Pump and Dump
What means pump and drump?
A pump is a coordinated, intentional, short-term increase in demand for a market instrument – in our case, a cryptocurrency – that leads to a price spike. Immediately after reaching the supposed peak, the coin is sold again at a significant profit (“dump” = to throw away, unload), causing the overall price to fall sharply.
The pump-and-dump scheme is much older than the cryptocurrency market, but it works particularly successfully here. But why? How does the scheme work?
Chat apps like Telegram and Discord promise encrypted and anonymous communication. Platforms like PumpOlymp list Telegram channels that are dedicated to this form of market manipulation.
Process
The P&D initiators gather about 1000 members in a Telegram channel they created. Only the initiators can post in this Chanel and “heat up” those present by pointing out the imminent start of the campaign. At this point, of course, the initiators do not yet reveal which coin it will be. Already, however, the initiators are buying, very cheaply of course, their chosen coin on their chosen crypto exchange. The initiators choose smaller exchanges like Cryptopia. There, rather “esoteric coins” with low market capitalization are hosted, whose price can be manipulated more easily compared to mainstream coins.
In the channel, P&D initiators eventually set a countdown announcing the launch e.g., in a few days. At the actual launch of the pump, the name of the selected coin and the crypto exchange is published. Immediately afterward, a massive price increase can often be observed. During this time, the initiators encourage the channel members to continue holding the coin. The initiators hope that more interested people, including outsiders/non-Telegram channel members, will jump up and buy the coin. Once the first sales begin (by the initiators), the dump will start. A chain reaction, as a result of which the coins are sold again in panic. The value of the coin falls quickly, often even below the initial value. The whole pump and dump action usually lasts only a few minutes, Benjamin Livshits and Jiahua Xu could show this in their paper [1]. Of course, the initiators can also be the crypto exchanges themselves in order to earn transaction costs or to push their own coins.
Why do people take part in such an action? You could say: pure psychology. The prospect of a big win, thinking they can outsmart the system, or the sheer thrill of it. It is common knowledge among P&D participants that the initiators profit the most from a pump. But channel members believe they could sell the coin at an even higher price to an even “greater fool” (see “greater fool” theory). At least before the first P&D, they think they can trick the system if they get out in time.
Is this legally permitted?
Yes and no, pump and dump is in a legal gray area. However, because many cryptocurrencies are not currently clearly classified as an investment or consumer products, the applicability of certain securities laws could be unclear, and to date, regulation of pump-and-dumps in the cryptocurrency market remains weak.
Therefore, when it comes to U.S. legislation, initiators could be prosecuted for false advertising under the Federal Trade Commission (FTC) Act (15 USC §45) or fraudulent misrepresentation, for example. Practically speaking, the anonymous communication on Telegram makes it impossible to track who or where the initiators are at all.
Can the P&D scheme be predicted?
Yes. Using fairly rudimentary machine learning models, the pump-and-dump target coins can be predicted very accurately, see [1].
