The cryptographic sphere is revolutionizing financial markets by providing an alternative independent from the traditional bank systems and opening new lines of investment to people all around the globe. As with any other unregulated space, however, this area does have its pitfalls. The most notorious means of destroying the “crypto” space is the “pump and dump” scheme. This type of market manipulation traps gullible investors and results in artificial price fluctuations of cryptocurrencies, leading to heavy financial loss.
In this article, we will discuss what a pump and dump scheme is, how it works, its influence on the market, and how investors can save themselves from falling prey to these manipulative tricks.
What is a pump and dump scheme?
Another form of financial fraud is in the manner of pump-and-dump scams. This is scamming the price of a certain asset through coordinated buying to inflate the price and then selling it at the peak when the price is soaring. Though illegal in the older financial markets, pump and dump scams may proliferate because the cryptocurrency space is largely unregulated.
A typical crypto pump and dump involves a group of people or entities scheming to accumulate a relatively unknown or low-volume cryptocurrency (often referred to as “altcoins”) at a low price. They use different tactics to “pump up” the value of the coin by actively touting it on social media, chat groups, or forums that convince others the coin’s value is ready to skyrocket. As the price peaks with the increase in demand, manipulators “dump” their holdings by selling the coin at inflated prices, leaving late investors with worthless assets. As the price drops again.
Also Read: Cryptocurrency Regulations by Country: A Global Overview of Digital Asset Policies
How does a crypto pump and dump scheme work?
The mechanics of a crypto pump and dump are quite simple, but the execution can be very cunning. Here’s a step-by-step walkthrough of how a typical pump and dump works:
Target coin selection: The masterminds behind the pump and dump scheme likely target a coin with low liquidity and low market capitalization. These coins are quite easy to manipulate since just a relatively minimal amount of buying will trigger huge price swings. Most of the time, coins from smaller exchanges without much liquidity and adequate regulatory enforcement available as in larger platforms such as Binance or Coinbase come under attack.
Coordinated Buying (The Pump): During the buying phase of the scheme, the organizers buy as much of the targeted coin as they can. They can do so secretly at first so no one suspects what is going on. Once enough coin has been acquired, coordinators start a coordinated campaign to promote the coin. The people who market it mostly do so within online communities, such as in a Telegram group, Discord channel, Reddit threads, or even YouTube videos, where they promote the coin and urge people to invest.
Other similar messages are the following: “This coin is about to explode!” and “Get in before it’s too late!” These messages are always used to create FOMO, or fear of missing out among rookie investors. As more people get hooked into the hype, the price of the coin starts rising, creating this sense of a real market rally.
The selling Phase or the Dump: The holdings begin to sell when the price of the coin has reached a sufficient level. The selling pressure dominates the market at this point, and the price of the coin crashed sharply. At this point, investors who bought during the pump are holding coins whose value has dropped critically.
Coin Crash: For the most part, the coin’s value tends to revert back to its original state or plummet even more after a dump. Often, the value of a coin completely dries up in minutes or hours. The masters and commanders behind this scheme drive away with their money, leaving those who fell for the hype behind in the dust with losses.
Why do pump and dump schemes persist in the crypto market?
There are a few reasons for it to be the perfect market for pump and dump schemes.
No Regulation: Whereas conventional financial markets do have rules in place, the crypto space is unregulated. While bigger exchanges have instituted some measures for not allowing the manipulation of markets, most other exchanges are subjected to less rigorous oversight. As a result, malicious actors are free to act without much fear of retribution by means of legal action.
Anonymity: Cryptocurrency transactions are done anonymously, hence making it pretty hard to identify those behind any pump and dump scheme. This throw a veil of anonymity for orchestrators since most the time law enforcement agencies cannot identify and bring to book those responsible for market manipulation in crypto space.
Low barrier to entry: The crypto space is open to any individual with an internet connection.
Effects of Pump and Dump Schemes on the Crypto Market
The crypto market suffers from various negative consequences due to pump and dump schemes. Some of these include:
Volatility in the Market: Pump and dump schemes cause extreme price fluctuations within the crypto market. Even though any speculative asset class is suppos to exhibit some degree of volatility. Artificially inflating and then crashing the price of a coin creates a highly unstable and volatile market environment.
Loss of confidence: Matured cryptocurrency markets have to gain investors’ confidence. A ‘pump and dump’ scheme builds a culture where manipulations and fraud become relatively common. Serious investors and institutions will not step into the market under such schemes. Slowing down the growth of the industry as a whole happens for lack of wider participation in the market.
Financial Loss: The most immediate cause of financial loss to a retail investor is the hype on a pump and dump scheme. A number of gullible people lose a significant amount of money after investing in the inflated value of some coin, but, as expected, later drop its price in the dump.
To not fall prey to some crypto pump and dump scheme, consider the following tips:
Do Your Own Research (DYOR): Before investing in any cryptocurrency, take the time to research the project thoroughly. Look at the team behind the coin, its use case, market capitalization, and trading volume. Avoid coins with low liquidity or that seem to be heavily promot without clear fundamentals.
Avoid hype investment. You see a particular coin going very rampant on social media or chat groups. Your instincts should signal danger. As pump and dump schemes depend on hype and FOMO, so do not invest based on emotion but always rationalize your choice.
Use Reputable Exchanges: One should use legitimate and well-reputed cryptocurrency exchanges that monitor their security measures for market manipulation. Good liquidity also makes it hard for price manipulators to inflate the prices as good exchanges normally have better liquidity.
Avoid that get-rich-quick scheme: If it sounds too good to be true, it probably is. Be wary of insinuations that a particular coin is about to increase in value overnight. No legit investment grows overnight, and there are no shortcuts to sustainable wealth in the crypto space.
Also Read: Celebrating Men and Their Contributions: International Men’s Day 2024
Conclusion
The world of cryptocurrencies is exciting and full of opportunities for investors. However, it also holds dangers at every turn. Pump and dump schemes in the market are highly prevalent, resulting in significant financial losses for victims who do not know anything about the manipulation. Having an idea of how it is done and their precautionary measures would make it easy to go through the crypto space with confidence and not be victims of manipulation in any way. Only proper research, caution, and a healthy dose of skepticism can be your ultimate defense against pump and dump schemes.
