By Lipsa Das
Nov 22, 2023 | Updated Nov 22, 2023
Read 8 min
Beginner
| KEY TAKEAWAYS: |
| — A crypto pump and dump scheme involves artificially inflating the value of a token with marketing or whale activity to attract more buyers, then selling the overvalued asset at a profit which removes the coin’s liquidity therefore crashing the price. — Pump and dump schemes typically have four phases: pre-launch, launch, pump and dump — with the first three phases designed to instill the FOMO within investors. — To avoid Pump and dumps, watch out for the red flags and use data and logic instead of emotions to make investment decisions. |
The crypto market has attracted a lot of individual and institutional investors over the past few years. However, this has also led to an increase in scammers who want to capitalize on the lucrative opportunities and the relative lack of regulations. Crypto scams lurk around every corner like hidden landmines—one wrong step, and you might never see your money again! But not all scams are the same; some wear their deceit like a badge, while others play a more subtle game of manipulation.
Pump and dump schemes are a nasty breed of crypto scams promising ridiculously high returns. These scammers leverage psychology to trap victims, playing on their emotions by dangling a carrot (read: “Get rich quick”). The victims often take the bait out of their fear of missing out (FOMO).
The more you know about crypto and its dangers, the less likely you will fall prey to these scams. In this article, you’ll learn how the pump and dump schemes work, how to spot the obvious and the not-so-obvious red flags, and everything in between.
What is a Crypto Pump-and-Dump?
A crypto pump-and-dump is a market manipulation scam where perpetrators create or obtain large amounts of an altcoin, promote it to fraudulently inflate (pump) the token price, and then cash out by selling (dumping) them to unsuspecting investors.
When perpetrators dump their tokens, the supply increases as the price decreases. Since many of these assets have little to no value, their prices will not recover after the scammers dump their holdings. In other words, innocent investors are stuck with nearly worthless tokens while the fraudsters count their loot.
Pump and Dumps: Explained
Pump and dump schemes aren’t exclusive to crypto—they have roots in traditional finance dating back to the South Sea Bubble in the early 18th century. Even the king of Great Britain, George I, bought stocks of the South Sea Company during its pump. When it crashed in 1720, Isaac Newton, the Royal Society, and countless investors, rich and poor, were among its victims.
Pump-and-dump fraudsters have evolved with time. Jordan Belfort, the lead character in ‘Wolf of Wall Street,’ went to prison for pumping and dumping penny stocks using cold calling through his brokerage Straton Oakmont.
Now, amid the regulatory gaps, crypto scammers are using the internet and anonymity to scam investors. According to Chainalysis data, 24% of all new tokens launched in 2022 showed signs of being a pump-and-dump scheme. Investors spent $4.2 billion buying these pump-and-dump tokens, while the fraudsters netted $30 million.
How Do Crypto Pump and Dumps Work?
Now that you have a basic idea of what a pump-and-dump scam is, let’s get you acquainted with its inner workings. From there you can easily identify project red flags and save yourself from getting dumped on!
Pre-Launch Phase
A pump-and-dump scam hinges on the marketing around a relatively worthless token. It’s all about hype—the higher it is, the more investors buy in, thus lining the fraudsters’ pockets.
They typically build up this FOMO feeling via platforms like X (formerly Twitter), Discord, and Telegram. Wherever there are uninformed people to target, scammers will strike.
Essentially, pump and dumpers employ tactics like allowlists and pre-sales to build a base of the first buyers.
An allowlist, sometimes called a whitelist, gives certain participants early access, and often additional privileges. Unfortunately, scammers use them to create an air of exclusivity and make you feel special. They sell you the idea of a unique opportunity to invest before everyone else.
If you’re on the allowlist, you can typically buy a coin or token before the general publicin a pre-sale. Sometimes you will even receive a discount too, convincing you further of the project. But it all goes downhill from there.
Launch
Leading up to the launch and even after, the scammers employ shillers to bring in more potential victims to the project. Crypto shilling refers to promoting a token or coin—usually by those with a large social media following or reputation and authority—to boost its perceived value.
The shillers use FOMO to create a sense of urgency and excitement. ‘You didn’t make it to the allowlist and missed the pre-sale? Well, here’s your very last opportunity to get in at the ground level and rake in millions later,’ they will tell you. The victims find themselves shilling the token for the scammers as they fall for the fake buzz.
Pump
The next stage is the pump. This means the list of doomed victims has already bought in, which causes the price of the asset to skyrocket. At this point, those who missed out on the pre-sale often feel like they’ve missed out. But there lies the folly. The more latecomer investors buy in at higher prices, the higher the price climbs. And unfortunately, that’s exactly what the scammers are planning.
Dump
Once the token price has reached a level the scammers deem profitable, they coordinate and dump their holdings simultaneously. This massive sell-off causes the token’s supply to far exceed its demand thereby tanking the price. This, in turn, causes panic among investors who also rush to sell. But for them, it’s already too late: the tokens have no value. All of the token’s liquidity is drained, leaving the scammers with a huge profit and the unlucky investors with worthless digital assets they cannot sell.
How to Spot a Pump and Dump: Top Red Flags
Now, let’s talk about how you can find the red flags that are the hallmarks of pump and dump operations. You don’t need in-depth technical knowledge to spot such flags, just vigilance. And, of course, it’s worth reminding you that if an investment opportunity looks too good to be true, it probably is a scam.
Allocation
When researching a project, find out how and where the token is allocated. To explain, speculating on the potential value of an asset requires you to know the total number of assets that will be issued, and where they may go.
You wouldn’t want to buy into an asset that allocates most of its tokens to a single centralized entity, would you? In this case, it would mean that central power would be able to sell all of their assets at once, causing a price dump. Thus, before buying in, you should always check out an asset’s plan for allocation including;
- The plan for its full allocation details
- Whether the founders or contributors own a significant portion of the total number of assets.
- The vesting periods and escrows for project insiders
You can cross-check their claims on-chain using block explorers such as Etherscan to see exactly where all of the tokens are. But of course, allocation is just part of the problem. What about the founders of each crypto project?
Founders’ Reputation
The reputation of the project’s founders speaks volumes about the token’s legitimacy and trustworthiness. Seek to answer questions like:
- Are the founders transparent about their identities and past projects?
- Have the founders been previously linked to any scams or controversies?
- Do the founders have a track record of building legitimate, successful projects?
- Are the founders’ social media profiles and online presence consistent and credible?
Inquiries along similar lines can help you discover hidden red flags, if any. In short, bad actors rarely strike once. That means if a founder has some skeletons in their closet, you might want to avoid their future projects.
Suspicious Social Media
You can detect some tell-tale signs of a pump and dump by monitoring the social media activity of the project.
Firstly, many pump and dump projects may turn off comments for their social media posts. Typically they do so to prevent negative feedback or to avoid questions. This is a very good method of spotting a scam, as any legitimate project usually encourages feedback and engagement.
Next, you may also encounter inflated follower or like/view ratios. If post engagement is typically disproportionate to the follower counts, it likely indicates fake engagement. You can also look into the accounts liking and commenting on a project’s post to discover if they seem genuine or not.
Finally, checking their Discord server for suspicious activity is also a good plan. Many pump and dump projects will have a Discord server teeming with unhappy community members or bots. Too many bots, a lack of genuine discussions, or a flood of complaints are all cause for concern.
Are Pump and Dumps Legal?
Pump and dump schemes in the stock market are illegal in several parts of the world, including the US, and EU, where securities laws prohibit it. That said, crypto scammers use anonymity to evade authorities, and crypto still lives in a regulatory gray area in most parts of the world.
As an investor, you want to remember to use data and logic, not your emotions and FOMO, to make investment decisions. Letting your emotions lead your investment decisions will drag you into traps like pump-and-dump scams.
Avoiding Pump and Dumps: Just One Way To Stay Secure
Pump and Dump schemes are far from new, but using new technologies, they are becoming smarter and less-detectable. Using your new-found analytics skills, and staying up to date with the latest scams can help you avoid them, but it’s not the only thing you can do.
To clarify, the Ledger Ecosystem can help you become better equipped to deal with bad actors. In Ledger Live you can access over 5,500 coins and tokens. Plus, you can clearly manage and track all of your assets in one simple place, meaning you don’t have to worry about recording the details of multiple accounts. Plus, all apps and services in Ledger Live’s Discover section benefit from a clear signing plugin, meaning when you interact with an external platform via Ledger Live, you can always read what you are signing in human-readable language and can sign in confidence reading the transaction details on your trusted display.
So what are you waiting for? Download Ledger Live, connect up your Ledger Device, and start exploring web3—with the benefit of security on your side.
