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Academics Analyze Crypto Pump and Dump Schemes in New Paper

Last Updated March 4, 2021 3:03 PM
P. H. Madore
Last Updated March 4, 2021 3:03 PM

Three university scholars – two from the University of Florida and one from Princeton – have concluded what many veteran cryptocurrency enthusiasts have long known and loudly preached: pump-and-dump schemes are bad.

In a new paper currently in progress  by Tao Li, Donghwa Shin, and Baolian Wang, the scholars provide evidence that market manipulation schemes “are detrimental to the liquidity and price of cryptocurrencies.”

CCN.com readers may have an interest in the context of the paper in relation to the recent activity at YoBit, in which the exchange itself openly promised to inject a ton of money into random coins in order to inflate their price.

What Is A Pump-And-Dump Scheme?

For the uninitiated, the term “pump-and-dump” might be foreign. Therefore we should first point out that these schemes did not begin with cryptocurrency and they will be around forever. That’s right: there is no eliminating the pump and dump scheme so long as people are free to make trading decisions on their own.

In any case, a “pump” is when a great deal of value is injected into a given stock, symbol, or, in our case, cryptocurrency, in a market sense. A hype cycle is often involved, and new products are especially likely to be P&Ds. A lone investor with a lot of capital or a small group of colluding entities can make a huge difference in weak markets. The examples in the cryptosphere are endless. One or two bitcoins can purchase a large amount of literally thousands of different coins, and if there are only a few exchanges listing a given token, the “price” will see a significant rise.

The “dump” part of the scheme is when the people acquiring the asset and necessarily driving its price to ridiculous highs sell off their stake to people who are none the wiser. The people buying at rates which previously would have been unreasonable believe they are buying long-term, solid assets. There is also a psychological element to both gambling and investing in which a dominant part of the human brain believes that things will be the way they are today tomorrow. The reality is that pump and dump schemes are hard to regulate without hard facts and informants because often enough, on the surface, they can appear like healthy boom-time trading.

The cryptocurrency sector has been rife with pump-and-dump schemes.

High-risk instruments trading has one goal: get out at the top, or nearest to the top that you can. Experienced traders understand that any asset can turn to absolute crap overnight. Traditional stocks can dive into the news cycle. The fundamentals are what matter. But with even more high-risk instruments, such as speculative technologies and the tokens that power them, the fundamentals are incredibly difficult to gauge. This reporter has dedicated a substantial portion of his life to covering the happenings around cryptocurrencies, tokens, and the like, and still, he is overly cautious in most investments surrounding them due to the simple fact that the future is unwritten, and something entirely unexpected can overshadow the basket you dump all your eggs into.

All of which is to say: trading amidst a pump and dump conspiracy is like being caught in a building victimized by arson. The arsonist is most likely to get out with barely even any smoke in his lungs if he gets burned at all. The rest of the people suffer from degrees. The last person to sell loses the most money.

Hype Is Important

The hype cycle is important to most of these schemes, but it is not absolutely necessary for success. A pump-and-dump expert could potentially fool a market mostly made up of trading robots. Inside information such as the said bots’ trading triggers would help a great deal. A pump-and-dump scheme can go for weeks or months, or it can last a few days. Often, hundreds of smaller traders participate in private Telegram groups with the intent of making each other richer.

As scholars write:

In the cryptocurrency market, manipulators often organize “pump groups” using encrypted messaging apps such as Telegram. They create Telegram channels and invite other investors to join. They frequently advertise on social media platforms to attract investors. A Telegram channel operator can post messages for other members to read. For a planned pump, the operator announces the target date, time, and exchange, usually at least one day in advance. However, they do not disclose the identity of the target token until the scheduled time. Members also receive multiple reminder messages before the announcement of the token symbol. As we show in this paper, a typical cryptocurrency P&D lasts for only several minutes. Therefore, it is reasonable to believe that Telegram channel members are important participants in P&Ds.

What it really boils down to is having enough money and the know-how to raise the price of a given asset. We don’t use the word “value” because the actual value of a token is relative to much more than what people on markets are trading it for that day. As an example, if Bitcoin dove 75% again tomorrow, its actual “value” would probably not be reflected in the market price. Likely as not, it would cost more to mine it, for a time, than it would buy it. But the value of Bitcoin is much more than what people are willing to pay for it at a given second. The price is a separate thing.

The most successful schemes happen at the launch of a token or a coin and are perpetuated by the creators or “team” themselves. Entire blockchains have been created and abandoned in the pursuit of sometimes small amounts of Bitcoin.

What Can Be Done?

As earlier stated, pump and dump fraud is like any other unsavory activity: it will always be there. How much and how often it is allowed to affect the rest of society is where positive action is possible. The study done by the authors reviewed a specific case, Bittrex, and its tactics attempting to mitigate or eliminate pumping and dumping on its platform. The results were apparently positive in nature:

Messages about pump groups on Telegram show that traders involved in P&D tactics had taken notice of the warning. Many scheduled P&D events were immediately canceled. For example, one prominent pump channel, “Trading signals for crypto,” canceled its P&D event on November 26, 2017. Some message groups solicited feedback from group members regarding whether to switch to other exchanges. Many message groups eventually ceased to pump tokens traded on Bittrex and/or switched to alternative exchanges such as Yobit.

Another conclusion of the paper is that newcomers are often looted of their initial investment. Again, in so many ways crypto trading parallels gambling: a new poker player might be bullied off his small stake by insane bets on the part of a bluffing veteran, or simply not know what they are doing and lose their money that way. The major difference is that a gambler understands it’s a just a game, whereas most investors are earnestly trying to make money, and often they are influenced by false information or downright lies. Resultantly, there is and may for the foreseeable future be “significant wealth transfer” from newcomers to immoral scam artists masquerading as investors.

And as long as there is a market for something, there will be a provider. We can’t stress enough how absurd it is for an exchange itself to openly “pump” coins at random, as Yobit has done. The next step is the exchange operators simply running off with the money, which has happened before. Perhaps it’s better than exchanges which do it on the sly, as most every exchange has been excused. Yet, there was long speculation that Crytpsy was pumping the price of Paycoin and other tokens using customer funds, and look at what happened there.

Featured image from Shutterstock.