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14.09.2018

What is a pump and dump in crypto trading?

We’ve all gotten caught up in the emotional rollercoaster of crypto at some point, but in the high risk high reward trading game, it’s often easier to fall victim to fake news and fake hype than we’d like to admit.

Do you consider yourself too smart to get scammed? Even the best traders screw up sometimes. The best prep is to understand who your up against, allowing you to avoid the scammers trying to separate fools from their money.

 

“Pump and dump” scams have been around as long as markets have existed, however, they are particularly endemic within in the cryptocurrency community where unregulated markets are common. While illegal in traditional equity markets, the unregulated nature of cryptocurrency markets have made them a target for malicious actors looking to prey on unbeknownst investors. This article examines the operations behind pump and dump scams while looking at common indicators for identifying and avoiding them. Remember, a good mantra to keep in mind when evaluating any trade is: if it’s too good to be true, then it probably is.

 

What is a pump and dump?

pump and dump

According to Investopedia, a pump and dump scam is the illegal act of an investor or group of investors promoting a stock they hold and selling once the stock price has risen following the surge in interest as a result of the endorsement. While this definition is concise for traditional equity markets, the extralegal environment in which most cryptocurrencies operate has made them even more vulnerable to such scams. For instance, as a direct consequence of the unregulated nature of cryptocurrency markets, cryptocurrency pump and dump scammers largely operate in the open. Unlike the secret boiler room operations that lead to the outlawing of pump and dump scams in the stock market by regulators, several pump and dump groups such as PumpKings, We Pump, and Crypto4Pumps have operated openly on platforms such as Telegram and Discord.

 

Pump and dump scams operate in a simple manner. A group of traders decides to inflate the price of a relatively cheap coin first by buying it in secret, then by pumping it across all available. social media channels. By choosing a coin with little supply and a small market cap, the coin price quickly rises as outside investors fall to fake promotional materials and other hype generated by the scammers. The initial mass purchase of such a coin by scammers along with the dissemination of fake positive news creates a chain reaction that artificially inflates the value of the coin as outsiders begin to buy in. Compounding this scenario is the fear of missing out and other emotional reactions to which beginner traders are vulnerable, causing them to buy in at exorbitant prices and leaving them with a heavy bag once the inevitable sell-off begins.

 

Once the value of the coin has risen substantially, the original pumpers begin to sell en masse to unsuspecting investors, capturing a huge profit while leaving those outside of the scam holding large amounts of relatively worthless coins. The massive sell-off by pump and dump scammers allows them to capture their profits while causing the coin’s value to deplete significantly, hence the “dumping” part of the scam.

 

Cynical estimates have argued that as many as one in ten ICO’s are pump and dump scams, or have perpetrated pump and dumps at least once during the ICO process. As long as cryptocurrency remains a thinly traded asset class, it will be vulnerable to pump and dump scams due to its susceptibility to market manipulation. As the crypto markets and community evolves, pump and dump scams will surely end, but until that day, buyer beware.

 

How to avoid pump and dumps

 

Fortunately, identifying a pump and dump scam is relatively straightforward and there are several metrics one can use. First off, a trader should analyze historical chart data. Here a pump and dump scam can be identified if historically low volume and low market cap cryptocurrencies begin to break out without warning.

Secondly, the rapid dissemination of fake news accompanying a break-out as unverified actors on social media post links to dubious sources or secret projects and partnership announcements Finally, undertaking your own fundamental analysis of any asset you wish to trade should be at the core of any successful investing strategy. Those who fail to perform their own due diligence or rely too heavily on technical analysis alone are particularly vulnerable to pump and dump scams as they fall for the hype or miss the context of a rise in price. Don’t be a blind trader: read the fundamentals and understand the asset you are buying before entering a trade.

 

Those participating in pump and dump scams are the parasites of the cryptocurrency community. By participating and encouraging such scams, they contribute to a negative perception of cryptocurrency, thus slowing down widespread consumer adoption. Fortunately, you can help stop pump and dumps by not participating, warning others, and even reporting scams to regulatory bodies where they exist. The Commodity Futures Trading Commision, the US regulatory body that regulates the derivatives markets, put out an announcement saying that it would pay a bounty to anyone who came forward with information leading to successful enforcement action against cryptocurrency pump and dump scammers. Indeed, you can make money doing the right thing.

 

The last word

 

The irony of transparent pump and dump scams is a telling symptom of rapid decentralization, however, in a community with roots in the libertarian and anarchist ideals of personal responsibility, do not expect change anytime soon. It is up to you, the individual trader, to perform your own due diligence on every trade. Without a disciplined regime of due diligence, any trader can fall to the malicious machinations of pump and dump scams.

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