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Following on from my article about Ponzi schemes, today we’re going to talk about another type of scam that many crypto projects are accused of being: the Pump & Dump. Like the Ponzi, all Pump & Dumps are financial scams, but not all financial scams are Pump & Dumps. Knowing what to look out for can help you correctly identify the risks to your investments, and make it a lot easier to convince friends and family to watch their backs, too.
What is a Pump & Dump?
A Pump & Dump is a type of financial scam that involves artificially inflating the price of an asset through false, misleading or greatly exaggerated information (the pump) so that the con artists can sell cheaply-purchased assets at a greatly inflated price (the dump). Since the price was artificially inflated, it usually drops significantly leaving buyers who were sold on the false information with significant losses. While illegal in regulated markets, there are no laws preventing Pump & Dumps occurring in the crypto world. As such the market is ripe for abuse, and investors need to be aware of them.
Let’s make one thing very clear here – just because they aren’t illegal in the crypto world doesn’t make them ethical or even justifiable, and it certainly doesn’t mean that they are good for the average investor. Pump & Dumps are a way of separating you from your money, and are never designed to benefit you, the average joe.
This is how they work
The instigators identify or create an asset that they can control large amounts of for a relatively small investment, for example, they buy up large quantities of a little-known currency for less than a cent per coin over a protracted period. The con artists then set about planting positive news stories about this coin, sometimes going so far as to pay celebrities to endorse it. As the public becomes aware of the asset, the price begins to increase, which gives the instigators more ammunition for their marketing campaign. They may start using third parties to buy up the asset whenever it becomes available, creating an illusion of scarcity. They will actively encourage their victims to hold onto their assets to “protect” its value, and in this day and age of online forums, they will shame anyone who sells out and takes a profit before they say it is time (spoiler: they will never say it is time).
As innocent holders of the asset see their investment increase, they will start to shill for it as well out of a genuine belief that it is rising on its own merits. Holders that suspect a pump & dump has started will at best sell and get out now with their profits before maybe admitting to others that there is a scam underway, and at worst actively participate in pumping to make more money. Even when people know full well that the asset is overpriced they will still buy in, convincing themselves they will be able to cash out before the whole thing comes crashing down.
Because crashing down is exactly what this asset will do.
When the instigators of the scam decide they’ve probably maxed out their luck and gains, they will sell their holdings. All of them. The sudden flood of assets onto the market brings the price crashing down because the illusion of scarcity has been ripped away, and as the price goes down people panic sell, driving it down even further. The instigators can make profits of several hundred percent returns on their investments. The people who didn’t sell before the dump are left with giant red lines on their portfolios and in some cases, an asset they can’t even give away. Colloquially, these folks are known as bag holders.
The History of Pump & Dumps
Recorded since the 1720s but probably far older, Pump & Dumps have a long history in parting the general public from their cash. One of the more famous cases is that of Jordan Belfort, the notorious Wolf of Wallstreet, who – along with colleagues at the investing firm Stratton Oakmont – used penny stocks to defraud investors through classic pump & dumps that cost investors a cool $220million.
While a great many Pump & Dump scams occur on the asset of an unsuspecting company, there are plenty of others, such as the Enron Pump & Dump, where the executives are the perpetrators. In this case, company executives were using a dedicated yahoo message board to orchestrate a pump & dump and related financial fraud so sophisticated that it fooled the top Wall Street analysts of the day. The executives lied about the company’s profitability and used shady accounting practices to hide the real picture, while at the same time using their yahoo board to warn key players when it was time to “dump” the stock. Twenty-nine Enron executives profited to the tune of a billion dollars by selling their overpriced stock to unsuspecting consumers, who were left holding the bag.
Why do pump & dumps work if they are such an obvious scam?
A couple of reasons. Firstly, don’t make the mistake of thinking that the con artists behind them are sleazy grifters, many of them are highly intelligent, cutthroat businessmen who are exploiting a loophole while they can. They will happily invest money into marketing, dodgy accountants, endorsements, bots and paid shills because they know that they need to fool cursory google searches. Con artists aren’t afraid of spending money to make money, and will employ the best they can to help them hide their activities. Don’t forget that it was the executives at Enron that perpetrated a Pump & Dump worth over a billion dollars – hardly the type of people that many would consider to be “typical” con artists.
Secondly, the crypto market is volatile as hell, which helps to disguise the pumping phase of this scam. We’ve all seen our portfolio lose/gain 25% overnight with the normal fluctuations. I mean, bitcoin. Is it any surprise that there are people who are willing to believe any and all cryptos have the potential to be worth over $10,000 in five years even if you’re buying it for $0.001 today? A pump & dump is different because the entire purpose is to artificially inflate the price far beyond its worth, and then scam new investors into buying coins at those inflated prices so that the con artist makes a fast buck.
Thirdly, and this leads on from the point above, never underestimate the power of FOMO (fear of missing out). When a crypto coin starts to gain significantly in value, those who haven’t invested in it start to panic that they’re missing out on the next bitcoin. When those rises are sustained for more than a few weeks, many will act irrationally and sell off legitimate but longer-term assets to jump on the pump train. It doesn’t even matter if they have done this before and lost – there is always bitcoin, shiny and expensive, to remind them that this time it might be different.
Lastly, the very nature of the crypto community provides cover for these con artists. While one of the advantages of crypto is the fact that communities can grow the adoption and value of a currency just through their own efforts, the downside is that it provides a convenient mask for pump & dumpers to hide behind. Memecoins are a particular problem here, as it can be difficult to parse out a group that yes, want to make money but are trying to grow the asset’s user base organically, and those who are willing to lie through their teeth to grow the asset just so they can sell it at 300% gains.
How to identify a Pump & Dump Scheme in crypto
Pump & Dumps work by convincing you that you need to join now or you’ll miss out on the chance to be rich, and that you shouldn’t sell your asset no matter what your brain, gut, financial planner or pet macaw are screaming at you. They aren’t always easy to spot because the very nature of the crypto market gives them plenty of places to hide, however the following flags should at least give you pause to do more research. If they all appear, then perhaps it’s time to reconsider investing.
A coin no one has ever heard of is suddenly rocketing in value
Unlike Ponzi schemes, where there never was any asset or fund, pump & dumps centre on an actual asset. They work best with assets that have a small market cap because the con artists can easily buy up a controlling share, and with assets that have very low value as this keeps their costs down. This coin could be brand new or it could have existed in purgatory for years; the flag to watch for is a sudden increase in value based on large scale purchasing without any related news or media to explain it. While there might be a legitimate reason behind the sudden growth in value, your job right now is to uncover it.
Keep in mind that while these schemes work best with the crypto equivalent of penny stocks, big name crypto is not immune, as the Enron pump & dump illustrates. Always do your research.
The coin has no purpose but its value is pumping
Whether you regard crypto as a store of value, like precious metals, or as a future replacement for fiat currency, there is one thing we should all agree on: for a cryptocoin to have value, it has to have a purpose. It doesn’t matter whether the purpose is noble or silly, just that it actually has one.
For most crypto this will be outlined in the developer’s white paper, which you should take the time to read even if you don’t understand half of it. Check it hasn’t been plagiarized from a legitimate project, and make sure that the bits you don’t understand make sense to people who do, and aren’t just cool sounding technobabble about blockchain revolutionizing how we farm Kumquats. Most importantly, make sure the white paper matches the tech.
As always, a dodgy white paper and use case indicates the possibility of a scam, but does not guarantee it, just as a slick whitepaper with strong tech doesn’t make a coin immune to a Pump & Dump scam. DO not fall into the trap of thinking that only good projects succeed and only bad ones are scams; in a Pump & Dump, product quality is irrelevant, but it’s more likely to occur on pointless coins that ones that require a lot of time and dedication to get working.
To the Moon!!!!!!!!!!!
If the coin is brand new, or if the coin has suddenly started increasing in value after doing nothing for years, be very wary if all the talk is about rocket ships, moon shots, and making investors overnight millionaires. In fact, be wary of this in general because no one, absolutely no one ever in the history of ever, can guarantee you will make a fortune off a single crypto coin. It’s one thing to say that you believe the product has value and has the potential to make a lot of money, but quite another to scream “buy now because we’re going to the moon and you’ll regret it for the rest of your life diamond hands hodl1!!!1!!”
While basically every crypto has a core following of fans that will hype the positive and bury the negatives, be aware that this behaviour, even when done unwittingly, is the hallmark of a Pump & Dump. I’ve seen people try to argue that it is marketing of all things – but it’s not marketing if someone is deliberately inflating the good news and actively hiding the bad to boost the coin’s value. Your best bet here is to actively seek out the bad data and negative news as well as the positive – although be warned, scammers operate here, too, in a scheme known as a Short & Distort, which will be covered in a future post.
Diamond hands and hodl!
This goes hand in hand with the above, but it’s important to note that Pump & Dumpers don’t want other investors to sell before they’ve made their own money, or they might be left out of pocket. They actively tell investors to hold onto their coins and never sell because the dip will be temporary, even when they know full well that it isn’t. Once they have their gains, they disappear.
Now in and of itself, holding through a volatile market is actually pretty good advice, because solid assets rise and fall, but thanks to the way our world works a diversified portfolio will generally finish in the green if you hold it long enough, but even then you have to sell in order to realise your gains.
Note the proviso: a diversified portfolio.
As stated earlier, no one asset is a guaranteed winner let alone a moonshot. Even a good, legitimate asset can become inflated in value, only to crash and take years, if not decades to recover (looking at you, silver bullion). You can blame anything from market manipulation to the weather, but the point is this: no one can guarantee you that the asset you are holding will make you a profit in one month, one year, or one decade, and you’ll definitely never make any money if you don’t actually sell.
If the talk from the coin’s creators or even a core group of newish community members is all about having diamond hands to the moon then be wary, there’s a chance you are talking to con artists, or their dupes. Remember, if you continue to hold even when everything is indicating you should sell, they can sell at a profit and leave you holding the bag.
Speaking of which:
I’m all in!
This is the biggest red flag for a crypto Pump & Dump I’ve seen yet. If people are proudly declaring that they have invested every penny they have – or worse, have taken out loans and invested them – into some random crypto coin then you’re either talking to a liar, a gambler, or an idiot. Whatever the truth, don’t take financial advice from them.
This is a classic misinformation strategy that feeds off FOMO and peer pressure and is designed to do one thing only: make people put more money into the coin to further inflate the price. They are trying to make you feel shame for not having their level of commitment, and will encourage others to board the crazy train with them. Buying in at the All Time High doesn’t benefit the purchaser, it benefits the seller and the holders. It is in the interests of the con artists to make you put as much money as possible into this crypto, driving the price up and the availability down, so that they can make the biggest returns.
Now the people claiming that they are "all in" might not be the con artists themselves but rather their dupes, but five minutes with google will find you plenty of stories of people who over-extended their credit to “invest” in an asset, lost it all when the crash came, and took their own lives as a result. Never, ever, ever give in to peer pressure and take on debt in order to invest. While there are some people who have made gains that way, there are a thousand more who ended up facing bankruptcy.
As always, hearing this about a specific coin doesn't mean there is a scam going on. It's a common enough joke on Reddit, and it might be that you're just talking to a lone muppet. However if it is a common feature of the community and worse, it is coupled with the shaming of people who have sold, you should approach with caution.
How long have those amazing gains being going for?
Like with Ponzi schemes, innocent people can make financial gains from a Pump & Dump, usually if they already held the asset prior to the pump stage, or if they bought in early enough that they can sell on the drop but still take a profit. If you have heard about the coin and it is already at an All Time High, be aware that the dump is coming any day now. You might get lucky and make a small gain before it crashes back down, but the odds are against you and the most likely outcome is that you will lose your money.
As with all of these flags, though, amazing gains alone is not an indicator of a Pump & Dump, as both Bitcoin and Ethereum can attest. That doesn’t mean that you should commit money without doing your research first, but if nothing else, consider limiting your investment to the same amount you’d be willing to lay on green at the roulette table.
Thus ends today’s lesson. Remember: All Pump & Dump schemes are scams, but not all scams are Pump & Dumps. They might be unethical and downright shady, but as of right now they are not illegal in crypto markets, so keep your eyes open and treat everything with a healthy dose of skepticism. Most importantly, though, remember that with the sheer number and range of scammers out there waiting to part you from your assets means that we are all susceptible to at least one of them. Knowledge is an excellent defense, so arm yourself.
