You’ve probably heard of Pump and Dump schemes, in which investors profit from a rapid price increase (pump) followed by an even quicker price drop (dump). These types of schemes might include a variety of assets, including cryptocurrencies.
Pump and Dump scams occur when a group of investors buys an asset early and then convinces other investors to buy it as well, driving the price up even higher. The initial investors then dump the majority or all of their tokens into the market, causing a market crash. Those who were not among the first to enter the market can suffer significant losses.
With a crypto Pump and Dump strategy, the technique is quite similar. In this article, we will go through how it works, give some examples, and talk about the risks and legality of Pump and Dump schemes.
What Are Pump and Dump Scams?
Pump and Dump schemes have existed since the beginning of the securities market. The concept is that when the price of a lightly traded asset, such as a penny stock, is low, a person or group of individuals buys into it.
They then begin spreading positive information about the asset. Most of the time, this information is completely false. The price of the asset continues to rise as more investors buy into it. Once the price has been completely “pumped,” the scam’s creator sells their portion to the remaining customers. Because they possess such a large percentage of the outstanding shares, the price dumps (falls).
Pump and Dump scams are a type of fraud, better known as market manipulation. The scheme’s creators want to mislead uninformed investors by encouraging them to buy an asset based on false information. When those investors buy in, the pumper sells, thus bringing the price down. As a result, the scammer makes a lot of money while the customer loses a lot of money.
In the securities market, there are a variety of rules that make this illegal. It is illegal to “obtain money or property by means of any false statement of a material fact or any failure to state a material fact,” according to the Securities Act of 1933.
How Does Pump and Dump Work?
Crypto Pump and Dump schemes consist of two stages: the pump, in which the price of an asset is raised, and the dump, in which prices fall due to a mass selloff.
During the initial phase, a group of developers or investors tries to convince others to buy a coin by distributing false information about it.
The creators of a crypto project might shill the project, claiming that if you invest in it, you will make millions within a month. Of course, you may see the good old Doge meme with a Shiba Inu dog sitting on a rocket.
Meanwhile, the misinformation-spreading investors already own a large portion of the coins. It’s possible that the project’s developers are spreading these statements in order to start a pump and dump.
The second step of a Pump and Dump strategy occurs once enough crypto holders have been persuaded to buy the new coin.
The initial investors begin selling their tokens after waiting for the price to climb to unreasonable high levels. As a result, the price drops down, perhaps causing others to sell as well. Thus, people who come in late and invest, usually lose a lot of money.
Example of Pump and Dump
Four members of the FaZe Clan took part in a Pump and Dump for a token named SaveTheChildren, in July 2021. Pro games and other influencers promoted the currency to their fans. When the price went up, they began selling the tokens they were given as part of the scheme, with some earning up to $30,000.
Later FaZe Clan came up with a statement on Twitter and announced that it had suspended some of its members.
A statement from FaZe Clan. pic.twitter.com/HnPXpAoSYX
— FaZe Clan (@FaZeClan) July 1, 2021
Shiba Inu is another example of a crypto Pump and Dump. The coin has no unique use case or characteristics. However, with a wave of celebrity endorsements, an ocean of fresh memes, and much noise about prices skyrocketing, SHIB became one of the top 10 cryptos by market cap in late 2021. Prices peaked above $0.00008 before quickly dropping below $0.00003.
How To Identify a Pump and Dump?
Doing your research is the first step in avoiding a Pumo and Dump scheme. If you see a relatively unknown cryptocurrency being promoted by strangers on the internet, don’t go in. Look up the token and read the white paper that came with it. Figure out who’s behind it and what their goals are. You should do this for each cryptocurrency to see if it has the potential to rise in value over time.
It’s best to avoid a token if it has been there for a while but the development of the project appears to have stopped. If the initiative has no clear objective, claims unrealistic advantages, as a well thought out development path, or is linked to prior bad actors, these are all warning signs.
Another significant red flag is if you don’t usually follow finance influencers, particularly cryptocurrency experts, but all of a sudden the individuals you follow start talking about a cryptocurrency. Consider why this ‘fashion’ influencer you follow is mentioning cryptocurrencies.
If you come across a potential crypto investment on social media, make sure the project has its own website and social media presence. Instead of depending on information from other parties, go right to the source. If there are no warning signs in the documentation or how the investment is offered, look at how the cryptocurrency performs. If it is traded on a popular exchange, it is more likely to be a safe investment. Cryptocurrencies such as Bitcoin and Ethereum are, of course, way safer than Altcoins, despite being volatile.
- Pump stands for a rapid price increase, dump stands for a rapid price drop.
- Pump and Dump scams are considered a type of fraud.
- Creators of these scams use misleading information to encourage investors in buying an asset they developed.
- After the price of the coin increases significantly, the creators start selling it, as such resulting in major profits.
- You can identify a Pump and Dump scheme by doing thorough research on the coin that is being hyped.