The exciting yet unpredictable world of cryptocurrency attracts not just investors, but also scammers looking to exploit them. One common trick is the “pump-and-dump” scheme, which lures people in with the promise of quick riches. This type of scam manipulates emotions, playing on the fear of missing out (FOMO) and the dream of getting wealthy fast.
Table of contents
- What Is a Pump-and-Dump Scheme?
- Pump-and-Dump Schemes in Traditional Markets
- The Rise of Pump-and-Dump Schemes in Crypto
- How Crypto Pump-and-Dump Works
- Famous Crypto Pump-and-Dump Scheme Cases
- How to Spot Pump-and-Dump Schemes
- How to Avoid Getting Scammed
- Legality and Regulations in Traditional Markets
- Is Crypto Pump-and-Dump Legal?
What Is a Pump-and-Dump Scheme?
A pump-and-dump scheme involves fraudulent market manipulation founded on the basic “buying low and selling high” principle of commerce.
Pump-and-dump schemes are a form of securities fraud that aims to artificially inflate (pump) the price of a stock or other investment through false hype by spreading fake or misleading information and coordinated buying. This then attracts unsuspecting investors to jump in, driving the price further up. When the price peaks, perpetrators quickly sell (dump) their holdings at a profit, crashing the price and leaving others holding worthless assets.
Pump-and-Dump Schemes in Traditional Markets
While seemingly born in the digital age, pump-and-dump schemes have long plagued traditional financial markets.
- Stratton Oakmont
In the early 1990s, this brokerage firm, led by Jordan Belfort (popularized in the movie “The Wolf of Wall Street”), was notorious for its aggressive sales tactics and pump-and-dump schemes involving penny stocks. Belfort and his team used high-pressure sales and false information to convince investors to buy low-priced stocks, then sold their own shares at inflated prices.
- Morrie Tobin
In 2018, Morrie Tobin, a Florida businessman, was involved in a $165 million pump-and-dump scheme using offshore accounts. He used social media and fake news websites to spread positive information about manipulated stocks, then sold his shares at the peak.
- Stock Influencer Group
In 2022, the SEC charged a group of social media influencers with a pump-and-dump scheme targeting small, unknown stocks. They used platforms like Twitter and Discord to spread false information and hype up the stocks, then sold their own shares at inflated prices.
The Rise of Pump-and-Dump Schemes in Crypto
Pump-and-dump schemes are illegal across the stock market. While government officials strive to prevent them in regulated markets like stock exchanges, these schemes can still occur in less regulated spaces like over-the-counter (OTC) markets and certain microcap cryptocurrencies.
The advent of crypto, with its decentralized nature, coupled with its unregulated and volatile nature, makes it a prime target for pump-and-dump schemes. The ease of creating new tokens and the lack of centralized oversight create a new playground for manipulators to orchestrate their scams.
In February 2023, a Chainalysis report identified that 24% of new crypto tokens launched in 2022 were suspected pump-and-dump schemes. Investors spent $4.6 billion buying these pump-and-dump tokens, while the fraudsters netted $30 million.
In another recent crime report, the blockchain analysis company found that about 24.4% of all tokens launched on Ethereum and 53.6% of tokens listed on decentralized exchanges (DEXs) met the criteria for potential pump-and-dump schemes. Market manipulators might have made over $240 million in 2023 by artificially inflating the value of Ethereum tokens.
How Crypto Pump-and-Dump Works
Cryptocurrency pump-and-dump schemes work similarly to other pump-and-dumps. A bad actor hypes up a coin (the pump) to get people interested in buying. Once the price is pushed higher by demand buying, they sell their holdings (the dump). To better understand this, below is a breakdown of how crypto pump-and-dump works.
The scammer (acting alone or in collusion with a group of persons) discreetly creates and/or accumulates a low-value, thinly traded cryptocurrency with minimal liquidity.
|Hype Generation Using social media, online communities, or paid influencers, the scammer spreads false or misleading information to create a buzz around the token. Another way is through pump groups, where members do a coordinated buying strategy that will drive the price up rapidly.
|The Pump Attracted by the hype and rising price, unsuspecting investors buy in, further pushing the price up.
|The Dump Once the price reaches a peak, the scammers quickly sell their holdings. Eventually, there is more selling than buying, causing the price to plummet.
|The Crash The scammers pocket their ill-gotten gains and disappear, leaving investors with nearly worthless tokens.
Famous Crypto Pump-and-Dump Scheme Cases
- Kim Kardashian Case
On January 7, 2022, a lawsuit alleges that celebrities Kim Kardashian, Paul Pierce, and Floyd Mayweather Jr. promoted a cryptocurrency called EthereumMax (EMAX) as part of a pump-and-dump scheme to defraud investors and profit for themselves. A recent ruling suggests that promoting crypto tokens without disclosing payment or without a legitimate basis could be considered an unfair practice, potentially making endorsers accountable.
- SQUID token
This token, inspired by the South Korean Netflix success, Squid Game, was a classic case of the pump-and-dump scheme. With SQUID being marketed as a play-to-earn cryptocurrency on social media to be used in a future Squid Game-inspired video game, its price soared 14,300,000% in a single week. The crypto coin peaked at $2,861 before plummeting to $0.0008. This incident eventually turned into a “rug pull” as developers took off with $12 million in investors’ funds.
- Arbitrade Ltd and Cryptobontix Case
On September 30, 2022, the SEC filed charges against Arbitrade Ltd., Cryptobontix Inc., and their principals for an alleged pump-and-dump scheme involving a cryptocurrency called Dignity (DIG). The scheme involved false claims about acquiring $10 billion in gold to back each DIG token, resulting in inflated prices.
How to Spot Pump-and-Dump Schemes
Unfortunately, anyone can fall prey to a crypto pump-and-dump scam. Many of those behind these schemes deliberately make them appear credible. That’s why it’s crucial to heed these warning signs:
⚑ Unrealistic Promises: Be wary of guaranteed high returns or overnight riches. Things that seem too good to be true usually aren’t.
⚑ Excessive Hype and Promotion: Watch out for coordinated efforts to promote a specific coin, creating hype in social media and pump-and-dump groups.
⚑ Rapid price surges for a new token: Beware of new or unknown coins experiencing sudden and dramatic price increases without any fundamental news or developments behind them.
⚑ Lack of Transparency: Look out for a coin’s website or whitepaper that lacks clear information about the project, team, and roadmap.
⚑ Pump Signal Groups: Avoid groups promising guaranteed profits through secret signals, as they’re often part of the scheme.
How to Avoid Getting Scammed
Aside from getting familiar with the red flags, another way to avoid or reduce the chances of being a victim of a crypto pump-and-dump is by sticking to major exchanges like the New York Stock Exchange (NYSE) or Nasdaq. These platforms have tough rules that weed out stocks ripe for “pump-and-dump” schemes.
In the crypto world, opting for established cryptocurrencies such as Bitcoin and Ethereum, or reputable exchanges like Coinbase and Binance, can offer a safer approach. Nevertheless, it’s essential to bear in mind that the crypto market inherently carries risks. Therefore, exercising caution is imperative, irrespective of how well-regarded your crypto or exchange is.
Ultimately, the best way to avoid the pump-and-dump trap is to research the project thoroughly. Be skeptical and don’t trust everything you read or hear. Do your research (DYOR) and verify information from multiple sources.
Here are some other resources where you can learn more about pump-and-dump schemes and how to avoid them:
- Securities and Exchange Commission (SEC): Investor Alert—Don’t Trade on Pump-And-Dump Stock Emails
- Commodity Futures Trading Commission (CFTC): Customer Advisory: Beware Virtual Currency Pump-and-Dump Schemes
- Financial Industry Regulatory Authority (FINRA): This On-Ramp Could Lead You to a Dump
Legality and Regulations in Traditional Markets
As said earlier, in most jurisdictions, pump-and-dump schemes involving securities like stocks are illegal. The Securities Act of 1933 specifically states that it’s a crime “to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact.”
Similar language can also be found in the Securities Exchange Act of 1934 which prohibits fraudulent activities, such as insider trading, and ensures that publicly traded companies must disclose important information.
In addition, a pump-and-dump may also be considered wire fraud because the fraudsters typically use communication methods such as email, direct messaging, social media platforms, or direct phone calls to pump the stock.
Violators of such acts can face legal consequences including hefty fines, imprisonment, and civil lawsuits. For instance, in the U.S., a conviction for securities fraud may lead to a maximum fine of $5 million and prison sentences of up to 20 years.
Is Crypto Pump-and-Dump Legal?
Why would anyone engage in a debate about the legality of an operation founded on false information and manipulation? Mainly because the legal limbo for crypto has not yet grown.
The decentralized nature of crypto makes it challenging to enforce regulations on such schemes. The legal landscape surrounding crypto is still evolving, with varying regulations across jurisdictions. For instance, the SEC has classified some tokens as securities, meaning pump-and-dump schemes involving them could be illegal. However, the classification of other tokens remains unclear.
Nevertheless, regulatory bodies are actively working on frameworks to combat market manipulation in the crypto space. For example, in 2022, the SEC successfully charged individuals involved in a pump-and-dump scheme related to a specific cryptocurrency.
Whether you suspect you’ve identified a crypto scam or find yourself entangled in one, it’s crucial to report it. The following contacts can assist you in taking action to ensure that scammers are held accountable and face appropriate legal consequences:
Commodity Futures Trading Commission (CFTC) at CFTC.gov/complaint
Federal Bureau of Investigation (FBI) at FBI.gov/contact-us
Federal Trade Commission (FTC) at ReportFraud.ftc.gov
Internet Crime Complaint Center (IC3) at ic3.gov/Home/FileComplaint
U.S. Securities and Exchange Commission (SEC) at sec.gov/tcr
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