Pump and Dump: Fraud through Cryptocurrency Price Manipulation

Many investors typically associate crypto fraud with broker fraud, where fake platforms steal money from their clients. Indeed, this is one of the most common methods used by fraudsters. The downside for the perpetrators is that sooner or later, the victims realize their money is gone and start fighting back. While the fraudsters often operate from abroad, buying themselves time to stay ahead of law enforcement, they must still expect to be pursued.

Another widespread method in the "crypto space" is the pump-and-dump fraud. In this scheme, the victims also willingly participate, but many do not even see themselves as victims. The pump and dump is difficult to prove as fraud for various reasons, and many investors don't understand that it is a serious crime.

We will explain how one of the oldest fraud schemes works, how to protect yourself from it, and what to do if you've fallen victim to a pump and dump.

How does a pump and dump work?

A pump and dump is a scam often used in the context of cryptocurrencies to artificially inflate the price of an asset, allowing the initiators to profit from the rising prices. This method is especially common in the crypto scene because the market is less regulated, and many affected investors have very little experience trading cryptocurrencies or engaging with the community. Various studies show this as well, as surprisingly many beginners have no prior experience in stock trading or a solid general understanding of financial products. This lack of knowledge works in favor of the fraudsters, as most of their victims even consider the pump and dump to be a legitimate method. After all, it is at least theoretically possible to make a profit if you're lucky.

However, the pump and dump is really only efficient for the perpetrators. They usually buy into illiquid assets at an extremely low price and benefit significantly from the growing interest they artificially generate. They do not rely on luck but rather control the process, and their profits come from the losses of other investors.

A pump and dump follows several phases, which can vary. The following description summarizes the general process.

Preparation: The initiators select a cryptocurrency

First, the fraudsters choose a cryptocurrency that usually has a low market value and low market capitalization. This is accompanied by low liquidity, and the trading volumes tend to be at the lower end of the scale. Such cryptocurrencies are easier to manipulate since even small purchase volumes can significantly affect the price. Additionally, with liquid assets, the fraudsters risk heavy market participants stepping in and using the pump and dump for sell-offs. In that case, the fraudsters would themselves incur losses.

In practice, fraudsters often show patience when buying into the assets. To avoid attracting attention from third parties, they buy small batches over weeks or months, which hardly appear in the order books and are adjusted to the trading volume. Alternatively, they create their own token via a smart contract, available only on specific decentralized exchanges. This method is becoming increasingly popular because fraudsters can allocate a large number of tokens to their own wallet at the start of the smart contract. However, this also requires them to imitate a liquidity pool at an Automated Market Maker (AMM) protocol, which can be significantly more expensive than buying into an illiquid token.

The Pump Phase: Artificially Inflating the Price

During the pump phase, the fraudsters either buy large amounts of the selected cryptocurrency themselves, which leads to a price increase, or they let their victims do the buying. Investors can pay to join so-called "pump groups," where the fraudsters provide them with supposedly hot investment tips. While the perpetrators have patiently bought in at low prices, they inform the first wave of victims in the pump group about which asset is going to be manipulated. The members of these groups are often referred to as the "inner circle," and the impression is given that these members enjoy a special status and can make significant profits. However, they do not have the same status as the fraudsters, and there is always the risk that the perpetrators will already use the inner circle to cash in their profits. After all, there is no guarantee that the fraudsters won't sell their assets to the pump group members themselves.

At the same time, they begin to aggressively promote the selected cryptocurrency on social media, chat groups, or specialized platforms. They often spread false or misleading information to boost enthusiasm for the coin and encourage more people to buy. Unlike with the pump group, these efforts target the general public.

In many cases, the fraudsters operate public chat rooms on Telegram or Discord. Here, they promote the paid access to the pump group and inform chat members, albeit with less priority, about planned activities. Purchases are often coordinated by giving the date and time. Only at the very last moment are participants in the public channel informed about which asset is being manipulated. Because everyone tries to jump on the bandwagon and buy at the same time, the price of the asset rises rapidly.

Other investors see the rapid price increase and want to profit from the seemingly lucrative gains. They too begin to buy the cryptocurrency, further driving up the price. This increase is intentionally reinforced by the fraudsters, who continue to spread positive news or even announce fake partnerships and projects that do not exist.

The Dump Phase: The Big Sell-Off

Once the price reaches a certain level and enough investors have entered the market, the dump phase begins. The fraudsters now sell off the cryptocurrency they bought at low prices at the prevailing market rates. Since they typically hold large amounts, their sale causes a sudden and dramatic price crash. With their investment often having increased tenfold or more, they aren't concerned about this. Instead, they use the demand in the order book as exit liquidity. It's likely that the fraudsters sell as soon as they deem liquidity to be sufficient.

Those who jumped on the "hype wave" are left holding their investments and usually suffer significant losses as the value of the cryptocurrency plummets. Meanwhile, the fraudsters have realized their profits and exited the market. Investors who belong to the "inner circle" can often also realize gains, although they are much smaller than those of the fraudsters. Subsequently, these people may even act as multipliers for the scam, promoting it and believing they have made legitimate profits.

The Consequences: Losses for the Victims

At the end of the pump-and-dump scheme, the affected investors are often left holding worthless or significantly devalued cryptocurrencies. They lose not only money but also often their trust in the market. Pump and dump schemes thus damage not only individual investors but also the overall reputation of Bitcoin and other cryptocurrencies. Since most victims do not understand that the fraudsters are to blame, they automatically assume that crypto as a whole is a scam.

In reality, however, only one party is to blame, although it must be acknowledged that prosecuting such cases is often challenging. The pump and dump scheme is not new but rather an old method that has spilled over into the world of cryptocurrencies.

The History of Pump and Dump: Origin and Evolution

The practice of "pump and dump" has deep roots in the history of financial markets, long before the term became popular. The fraudulent tactic of market manipulation is almost as old as the stock market itself.

The origins of pump and dump can be traced back to the 18th and 19th centuries when financial markets were much less regulated. One of the earliest documented cases of market manipulation occurred during the South Sea Bubble in 1720. Unscrupulous traders persuaded investors to buy shares of the South Sea Company by exaggerating the company's value. The stock price soared, only to crash dramatically when the company's true financial situation became known.

In the 19th century, similar fraudulent schemes were carried out in the emerging stock markets of the United States. The so-called "boiler rooms" were notorious for aggressively promoting stocks of companies, often with false or misleading information. These unregulated practices were especially common during the Industrial Revolution, when new companies were going public, and speculation was widespread.

With the increasing regulation of markets in the 20th century, particularly following the Great Depression and the introduction of the Securities Act of 1933 in the U.S., it became harder to carry out large-scale pump-and-dump schemes. Nevertheless, fraudsters continued to find ways to manipulate markets. In the 1980s and 1990s, with the rise of penny stocks (very low-priced shares of small companies), pump-and-dump schemes experienced a resurgence. Infamous examples are depicted in films such as "The Wolf of Wall Street," which shows how shady brokers persuaded naive investors to buy worthless stocks at inflated prices. With the advent of the internet in the 1990s and early 2000s, the dynamics of pump-and-dump schemes changed once again. Online forums, email lists, and later social media provided new platforms for fraudsters to execute their strategies. Often, a stock was hyped in online communities, only to be sold off shortly after the price had skyrocketed.

Cryptocurrencies are thus the latest development in a long history of fraudulent marketing of assets. The fact that the crypto market is largely unregulated globally, combined with the relative anonymity compared to stock markets, makes digital currencies attractive for such frauds. Since it is easy to coordinate groups on social media and through messenger services as described, to drive up the price of a particular cryptocurrency and then quickly sell off, the market in its current form provides the perfect breeding ground for these crimes.

What are German authorities doing against Pump and Dump schemes?

Pump-and-dump schemes pose a significant threat to the integrity of financial markets. In Germany, the Federal Financial Supervisory Authority (BaFin) is the central regulatory body responsible for preventing and punishing such market manipulations. With the increasing importance of cryptocurrencies and digital assets, BaFin and the European legal framework play an ever more crucial role in combating these fraudulent practices.

BaFin monitors the German financial market and enforces both national and European laws to prevent market manipulation. Regarding pump-and-dump schemes, BaFin focuses on several key areas:

• Monitoring and Investigation: BaFin actively monitors the trading of securities and other financial instruments to identify suspicious activities. This includes unusual price movements, trading volumes, or suspicious communication patterns on social media. If market manipulation is suspected, BaFin initiates investigations and works closely with other national and international authorities.
• Prosecution: If a pump-and-dump scheme is uncovered, BaFin can take legal action. This can result in hefty fines and, in severe cases, prison sentences for the perpetrators. BaFin can also suspend trading of the affected financial instruments to prevent further damage.
• Preventive Measures and Education: BaFin also relies on preventive measures to inform the public about the dangers of pump-and-dump schemes. Through informational campaigns and warnings, BaFin aims to raise awareness among investors and make such frauds harder to execute.

MiCA – The European Framework for Cryptocurrencies

With the growing spread of cryptocurrencies, the European Union has introduced the Markets in Crypto-Assets (MiCA) framework, which is set to come into effect in 2024. MiCA is a comprehensive legal framework aimed at protecting market integrity in the crypto space and creating a safe environment for investors. BaFin plays a key role in implementing and enforcing this framework in Germany. MiCA also includes several important aspects designed to protect the market from pump and dump schemes:

• Transparency Requirements: MiCA imposes strict transparency requirements on crypto-asset issuers. Companies that issue cryptocurrencies must disclose detailed information about their projects, making it harder for fraudsters to artificially inflate the price of a coin or token.
• Market Monitoring: MiCA requires platforms that trade crypto assets to implement strict monitoring mechanisms to detect suspicious activities. These platforms must regularly report to BaFin and take immediate action if market manipulation is suspected.
• Investor Protection: Another key element of MiCA is investor protection. Through clear disclosure obligations and the prohibition of misleading advertising, investors are better protected, reducing the risk of them falling victim to a pump-and-dump scheme.

Despite the regulatory reforms at the EU level and the measures taken by supervisory authorities, investors should remain vigilant. Especially on decentralized exchanges, certain measures by the authorities are difficult to enforce. While stablecoin and exchange providers face increasingly strict regulations, fraudsters are shifting their activities more and more into the DeFi sector.

5 Tips on How to Protect Yourself from Pump and Dump Schemes

1. Beware of Sudden Price

A typical feature of a pump-and-dump scheme is a sudden and often inexplicable rise in the price of a cryptocurrency. Investors should be cautious when they see such drastic price gains, especially with lesser-known or smaller coins. It is important to observe the market and not blindly jump into a hype.

2. Avoid Questionable Sources and “Insider Tips”

Pump-and-dump schemes are often organized via social media, messenger services, or online forums where insider tips or allegedly exclusive information are shared. Investors should be skeptical of such sources, especially if the information comes from unknown or untrustworthy individuals. It is advisable to rely only on established information sources and not be driven by FOMO (Fear of Missing Out).

3. Avoid Illiquid Markets

Pump-and-dump manipulations occur more frequently with cryptocurrencies that have a low market capitalization and low liquidity, as it is easier to manipulate the price of such coins. Investors should focus on more well-known and liquid markets, where the likelihood of manipulation is lower.

4. Regularly Monitor News and Developments

Actively monitoring news related to the cryptocurrencies you have invested in can help to identify potential pump-and-dump schemes early. If news and information do not justify the price increase, this could be a warning sign.

5. Choose Regulated Exchanges

Trading on regulated exchanges provides additional protection, as these platforms are subject to strict regulations and generally have mechanisms in place to detect and prevent suspicious activities. Regulatory authorities like BaFin in Germany or the SEC in the US work to make the market safer and limit pump-and-dump schemes. In Germany, Coinbase, AnyCoin Direct, and Bitpanda are regulated by BaFin. Other providers like Bitvavo and Kraken are currently working on obtaining the necessary licenses.

Can you get your money back?

For investors who have fallen victim to a pump-and-dump scheme, the question arises whether they can recover their losses and hold the fraudsters accountable. This is possible, and there are various ways to achieve this. Depending on the specific circumstances, it may even be possible to claim compensation from exchanges and brokers. Initially, it is advisable to thoroughly document the case and secure evidence.

CryptoTracing can assist you by working with our partner attorney to take all necessary steps and, if needed, represent you in court and with authorities. Additionally, transactions on decentralized exchanges can be uncovered through blockchain analysis. If the fraudster has cashed out in a pump-and-dump scheme, it may be possible to track transactions and gather information that could reveal their identity.

Use our contact form to describe your case. We will get in touch with you promptly and provide a free initial consultation, explaining which steps we consider reasonable and what actions should be taken.

FAQ on Pump and Dump