How to Defend Yourself Against Pump-and-Dump Crypto Scams

"Pump and dump" schemes have been around since long before cryptocurrency was invented. What's striking about the crypto markets is that this type of manipulation is done out in the open.

On various social media channels, for example Telegram, BitcoinTalk and Reddit, groups of individuals come together and agree to buy altcoins at a certain price and to sell simultaneously at a specific time when the price peaks. They often spread false or misleading information to persuade unsuspecting investors to buy during the run-up.

But you have to give them credit for one thing: they don't couch their activities with euphemisms.

Just look at the names of the top five P&D chat groups on Telegram, according to Business Insider:

PumpKing Community (14,317 members)
Crypto4Pumps (7,602 members)
AltTheWay (5,582 members)
Pump.im (148 members)
OCPump (1,281 members)
While this twisted sort of transparency may be refreshing when compared to the secretive manipulation of Libor by traders at large banks a decade ago, the prevalence of these groups underscores the hazards facing investors in cryptocurrency.

"This has a negative effect on the overall market and easily creates fear, uncertainty and doubt (FUD) in the overall crypto community," said Oleg Seydak, the CEO of Blackmoon Financial Group, a platform for marketplace lending of cryptocurrency.

"This type of manipulation unfortunately affects a great majority of new crypto investors and if we want the industry to prosper, we need to work together to prevent and shut down these channels and groups," he said.

Potential solutions
How, though? One way is to encourage whistleblowing.

The Commodity Futures Trading Commission (CFTC), the U.S. agency that regulates derivatives, announced in February that it would pay a bounty to those who come forward with information that leads to an enforcement action.

Another potential solution is a self-regulatory organization (SRO) like the one proposed by by Gemini founders Cameron and Tyler Winklevoss. The concept has the support of CFTC commissioner Brian Quintenz. But it's unclear whether an SRO would have any teeth.

Until regulators come up with rules to curb P&D scams, investors need to be extra cautious they don't get taken for a ride.

Psychology is key behind these scams. Beware as fraudsters are usually masters of persuasion and will tailor their pitches to tap into their targets' psychological profiles.

Remember, if it sounds too good to be true, it probably is.

Keep your guard up
For an illustration, below is a screenshot of a P&D group in action, courtesy again of Business Insider. Note the breathless language that tries to capitalize on FOMO (fear of missing out): a coin's price is "flying"; it's "so cheap now."

Proceed with extra caution around tokens issued from initial coin offerings (ICOs), as some have estimated that perhaps one out of 10 ICOs has used this scheme at least once.

According to a January blog post by Sergey Khorolskiy, when some ICO teams understand that their project is close to failure, they organize a pump and dump. The strategy is simple: Using all types of social networks, they begin to "shoot" followers with good news.

Cryptocurrencies in general are susceptible to manipulation because, like penny stocks, they are thinly traded when compared to mainstream financial assets.

"One investor can drive prices on a single exchange by taking a large position one way or the other, or simply by putting out a large bid or ask that by itself moves the market," said Trace Schmeltz, a partner in the Chicago and Washington, D.C. offices of Barnes & Thornburg LLP.

What's more, "for cryptocurrencies that trade on multiple markets, a trader could potentially move the market globally by moving the price on a single exchange."

For this reason, investors should be wary of following pricing as reflected on less well-established exchanges, Schmeltz added.

Like it or not, crypto is here to stay. As the market evolves the scammers and fraudsters will be weeded out as regulation is enforced. Until then, we can expect there will some tears along the way.