How To Identify A Crypto pump and Dump

Understanding crypto pump-and dumps

The crypto industry remains the Wild West. There are dozens of exchanges, and it’s relatively easy to issue a new cryptocurrency. Therefore, it’s a breeding ground for thinly traded currencies and scammers who can pump and dump those assets.

Typically, a pump-and-dump crypto scheme starts with an organizer gathering influencers in a private group online. They’ll coordinate buying the target crypto asset to avoid price spikes. Once they’re ready to pump the asset and get the general public to buy in, the influencers will share information about the trade with their followers on social media. The organizers will then coordinate the sale, e.g., the dump, in order to get everyone paid, leaving the public investors holding the bag.

What makes crypto especially susceptible to this ploy is that organizers don’t have to search very hard for thinly traded crypto assets. They can just create them. The barrier to entry for creating a new cryptocurrency is just a little bit of research and coding knowledge.

Furthermore, newly formed cryptocurrencies are largely unregulated. A person or group can create a token and make wild claims about its use, and it’s unlikely they’ll face repercussions when those claims turn out to be nothing but false promises.

For example, several members of FaZe Clan, an esports and influencer group, promoted a new cryptocurrency called SaveTheKids in the summer of 2021. The coin promised to help children around the world, but it turned out to be no more than a scam. The organizers and influencers made off with tens of thousands of dollars, and their followers ended up with a worthless crypto token. Needless to say, no kids were helped.

How to spot a pump-and-dump crypto scam

It’s easy to identify a pump-and-dump crypto scam after the fact. But that doesn’t do cryptocurrency investors much good when the rug’s been pulled and they’re left holding the bag. It pays for investors to know the signs of a potential pump-and-dump scam before it actually happens.

The first step in avoiding a pump-and-dump scam is to do your research. If you see a relatively unknown cryptocurrency being touted by internet strangers, don’t rush to get in. Look up the token, find its white paper, and read through it. Determine who’s behind it and what the objectives are. You should do this for any cryptocurrency to determine if there’s long-term potential for it to increase in value.

If the token has been around for a while but development on the project seems to have disappeared, it’s best to avoid it. If the project has no clear purpose, it purports benefits that seem unrealistic, its development roadmap isn’t well thought out, or it’s associated with previous bad actors, those are all red flags, too.

If you don’t typically follow influencers in the finance space, specifically cryptocurrency experts, but all of a sudden the people you follow are talking about a cryptocurrency, that’s another big red flag. Ask yourself why this fashion influencer you follow is talking about some cryptocurrency.

If you do discover a potential crypto investment on social media, it’s best to check out whether the project has its own website and social media presence. Go straight to the source instead of relying on information from third parties.

If you don’t find any red flags in the documentation or in how the investment is being promoted, take a look at how the cryptocurrency trades. If it’s on a well-regarded exchange, it’s more likely to be a safer investment. If you have to dig into some unknown DeFi exchange, you’ll want to dig deeper into the order book.

Most exchanges will show you all the open orders for an asset, as well as the order history. Check the pattern on trading volume. If it’s spiked recently and volume appears to be trending higher, be cautious. If you see big walls of the crypto asset on the buy side, there’s potential that a big group is making sure the price of the coin doesn’t fall below that price. Likewise, you may see big walls of sellers to make sure the price doesn’t pump too fast as the organizers pile into the coin.

If you suspect a cryptocurrency is undergoing a pump-and-dump scam, it’s best to avoid it. It’s impossible to know without inside information when the organizers plan to sell. If you do have inside information, though, you’re probably better off contacting the Commodity Futures Trading Commission (CFTC)and providing the information to them.

The CFTC put out an advisory in late 2019 to warn investors about potential pump-and-dump scams. It’s offering bounties to any whistleblowers. That means you don’t have to do anything illegal, and you might make more money by being an informant.

Can You Profit from Crypto Pump and Dump?

Pump and dumps result in large swings in price movement, which can produce large gains. Profiting from pump and dumps, even unknowingly, is possible if you’re on the right side of the trade. If your timing isn’t right and you get caught on the wrong wave, you might have trouble profiting from pump and dumps.

Spotting a pump and dump strategy requires having enough confidence that the group you’re following will be first to the punch and artificially inflate prices. You’ll also need to be able to exit the trade in time to make money.

To minimize losses, you can set a trailing stop loss that helps you exit a position in case prices quickly move sharply downward. This means setting a sell order at a specific price to keep any losses minimal, removing your position in the coin. Otherwise, if you hold on to a position for too long and exit slowly, you may end up a victim of falling prices from the dump.

Is Crypto Pump and Dump Illegal?

With all the news and hype around cryptocurrencies, aren’t there laws in place to protect consumers? The answer is: yes and no. Most countries have some laws on the books regarding intentional fraud.

For example, in the United States, the Federal Bureau of Investigation (FBI) has an internet crime complaint center which monitors online fraud. However, due to the nature of cryptocurrencies, it’s hard to nail down which body regulates them. Depending on the regulatory agency, a cryptocurrency can be considered money, property, security, or a commodity. This means it’s regulated by either the Internal Revenue Service (IRS), the Commodity Futures Trading Commission, the Securities and Exchange Commission, or the Financial Crimes Enforcement Network (FinCEN).

Pump and dump schemes are illegal in stocks. But in general, current laws regarding pump and dump schemes don’t apply to cryptocurrency exchanges and coins that aren’t classified as securities. This could change in the future, but for now, the regulatory vacuum creates a gray area in which pumps and dumps operate in cryptocurrencies.

One possible hangup right now for schemers in the U.S. The IRS has been tasked with overhauling how it looks at capital gains, so perpetrators of the schemes may run into issues if they don’t pay taxes on their ill-gotten profits.

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