Cryptocurrency is a largely unregulated industry which sometimes means anything goes. With digital currencies, digital wallets, mobile apps and transactions being made on a blockchain technology, the industry is rife with vulnerabilities, scams, and hacks. As interest in cryptocurrency increases, so does the proliferation of fraud. Generally, the market experiences low trading volumes on most days with occasional volume and price spikes coming into play. But are these price spikes genuine or are they a result of pump and dump schemes? We take a look what what cryptocurrency pump and dump schemes are, how the impact the market, and the signs you should look out for.
What is a pump and dump scheme?
A pump and dump scheme refers to a group of people artificially inflating the price of an asset through false and misleading information. In essence, they will buy an asset for a low price all at once, prompting the price to rise. This sudden and rampant increase in an assets nominal value will prompt unknowing traders to jump in and purchase the asset as they hope to ride a bull market. The original buyers then sell (dump) the assets to make a quick profit. This shift in supply and demand often causes many users to make a significant loss.
How do they work?
At the heart of all pump and dump schemes is a group of core organisers. These organisers prompt other people to join in their scheme. Pump and dump schemes are often promoted through social media and messaging platforms such as Telegram.
The pump and dumpers select a coin and an exchange to target. The aim is to drive up the selected coins volume. The ideal target will have low volume, allowing the schemers to lock up as much of the available liquidity as possible. Consequently, the schemers will be able to fix the price whilst they sell off their newly acquired coins.
While pump and dump schemes may seem like profitable opportunities, it is generally the core organisers who stand to make the most money. This is because they know when the pump is going to happen. Any one else involved will likely be tiered and receive the ‘tip’ dependent on their rank. The reality is — particularly if you are ranked at the bottom — you are going to lose money.
Don’t give in to FOMO
You can typically recognise a pump and dump scheme through the way it’s advertised. Social media adverts will typically promote the event by promising instant profit. It seems too good to be true, because more often than not, it is.
Since Bitcoin first went mainstream, it soared to a record high in 2017. This left many feeling as though they had missed out. This feeling is dubbed as ‘FOMO’ – the fear of missing out, or the fear of missing opportunity. Many pump and dump schemes will outline an attractive reasoning for the event and entice individuals who fear missing out on the reward.
One way to avoid being a victim of a pump and dump scheme is to not give in to feelings of FOMO. Any investment decisions you make should be backed by market research and an understanding of ongoing trends. Staying on top of the latest news will help you to keep ahead of the market and to spot potential pump and dump schemes.
There are a few warning signs that indicate a scheme may well be a potential pump and dump.
- Examine if the company/promoter have recently been suspended by the U.S. Securities and Exchange Commission (SEC). Don’t just stop at the first company/promoter though. Dig deeper and try to determine whether the head of the company/promoter has been suspended at an earlier date.
- If there’s an increase in an asset’s value at the same time promotional activity is occurring, do not buy. If an asset’s price suddenly soars and it looks unusual, it more than likely is.
- Press releases or promotions may announce events that don’t actually happen. This is a sign of false advertising ahead of a scheme.
- Check if the company/promoter has real business operations. If they don’t, they are likely bad news.
- If the company/promoter has a lot of shares without a corresponding increase in the company/promoter’s assets, avoid doing business with them.
- A bad sign for a company/promoter is if they frequently change the companies name, management or type of business.
To find out more about cryptocurrency trading and danger signs to look out for, read our essential how-to guides.