How to spot a crypto pump and dump scheme

Today bitcoin has become an accepted alternative asset class with regulated exchanges, US approved ETFs, institutional investor interest, and its own futures contracts.

At the same time many altcoins are still operating in a 'wild west' type environment - with even 'reputable' projects still being victimized as historic 51% attacks on Bitcoin SV and Ethereum Classic have shown. Despite the bear market, 2022 has been a busy year for crypto scams and investors need to be aware that many so called 'crypto projects' are only established to separate gullible investors from their money.

John McAfee was to be charged as a pump and dumper

In May 2021, US federal prosecutors announced their intention to charge recently deceased tech entrepreneur John McAfee, after linking him to several pump-and-dump initiatives involving crypto assets.

Authorities alleged that between 2017 and 2018, McAfee promoted a “coin of the day” via his Twitter account without disclosing to his followers that he and his associates had already purchased positions in the coin that they would sell once the price pumped.

The scheme involved numerous digital assets, including Verge (XVG), Dogecoin (DOGE), and ReddCoin (RDD). This enforcement action was the first brought by the CFTC for a manipulative scheme involving digital assets. “Manipulative and fraudulent schemes, like that alleged in this case, undermine the integrity and development of digital assets and cheat innocent people out of their hard-earned money,” said Acting Director of Enforcement Vincent McGonagle. “Financial innovation is constantly breaking new ground, and the CFTC’s enforcement efforts must keep up. We will always act to hold fraudsters and manipulators accountable for misconduct.”

Celebrity endorsements like McAfee’s should always be treated with skepticism. It is against the anti-touting provisions of US securities laws for celebs to make such endorsements without revealing they’re being paid to do so - but it happens all the time.

Actor Steven Seagal, for example, found out he wasn’t above the law in 2020 and settled charges of failing to disclose around a million dollars in payments he received for shilling Bitcoiin2Gen. The SEC said that Seagal was promised $250,000 and $750,000 in tokens for his celebrity endorsement, but never revealed to investors that he was being paid.

Did Elon Musk pump and dump Bitcoin?

When Bitcoin fell more than 50% from its April 2021 high of $64,000, Tesla CEO Elon Musk was forced to deny claims that he had pumped and dumped Bitcoin.

The denial was prompted after an accusation by Magda Wierzycka, the CEO of financial services firm Sygnia. Wierzycka said, "the volatility we have seen is an unexpected function of what I would call market manipulation by Elon Musk, and if that happened to a listed company he would be investigated and severely sanctioned by the SEC." Wierzycka, who made the comments in a podcast, accused Musk of buying a position in BTC, then announcing its position to pump the price, before selling at the peak.

In response, Musk said that "Tesla only sold ~10% of holdings to confirm BTC could be liquidated easily without moving the market," a reference to Tesla's first-quarter bitcoin sale that resulted in proceeds of $272 million after several tweets touting the cryptocurrency.

It is worth remembering that Musk paid US$40 million in 2018 to settle SEC charges against him for his tweets about taking Tesla private. According to the SEC’s complaint, Musk’s misleading tweets caused Tesla’s stock price to jump by over six percent on August 7, 2018 and led to significant market disruption.

The SEC also charged Tesla with failing to have required disclosure controls and procedures relating to Musk’s tweets, a charge that that the company agreed to settle.

What is a crypto pump and dump scheme?

Pump and dump schemes are nothing new - they are a form of securities fraud that have existed for decades and originally focused on the equity markets. More specifically, on small-cap stocks. An equity markets, pump and dump scheme works like this. A small group of investors select and purchase shares in a company with a low market capitalization, thereby causing an initial jump in price.

Next, call center operations – more commonly known as boiler rooms – call potential private investors with the aim of convincing them to purchase the stock by providing false information claiming the stock is about to experience substantial gains. Once enough investors have been misled into purchasing the stock and its price has risen by enough, the initial group of investors will sell their holdings to take profit, before the price collapses and all following investors make heavy losses.

This type of securities fraud has also made it into the cryptocurrency markets. While the modus operandi has changed, pump and dump schemes are alive and kicking in the altcoin market due to its unregulated nature.

These schemes target low capitalization cryptocurrencies and digital tokens that can easily be manipulated with low trading volumes. Instead of boiler rooms, the price pumps are conducted by spreading hype and fake information about a coin on social media.

The comments section of crypto-related videos on YouTube is a prime target for coin hype. For example, the Brave New Coin YouTube channel’s comments section is moderated on a daily basis for potential pump and dump scams. In this scenario, people attempt to hijack discussions and inject comments about a coin they are trying to hype into otherwise genuine conversations.

As the examples below show, the format is easily recognizable - typically beginning with a thank you and then an inquiry about a certain coin or project. Posted on many other channels, these types of comments give the impression there is genuine enthusiasm about a project, whereas in reality there is no such groundswell of interest.

Communication among pump and dump group members happens on encrypted messaging services such as Telegram, where groups can contain several thousand members and are usually entered upon invitation.

In these group chats, a coin that will be “pumped” will be announced after the original perpetrator of the scam buys the coin. Within minutes, group members also buy and then spread fake news about the coin on social media, blogs and sometimes even on news outlets thought of as reputable through paid-for sponsored content.

Once the price has jumped, the initiators of the pump sell their coins, followed by other members in the pump and dump messaging group. Then the price collapses again, leaving all investors who bought after the price surge with steep losses.

Furthermore, these Telegram chat groups have also been targeted by hackers. SafeGuard Cyber says it recently discovered a remote access trojan (RAT) virus posted in a crypto investment public Telegram chat. The company says the purpose of this Trojan was to steal Bitcoin keys.

Another phenomenon that is separating vulnerable investors from their money is crypto projects that don’t even bother with the pretense of creating a product or a use case. Many times Brave New Coin has been approached by projects wishing to buy advertising to promote their ICO or capital raise.

Close examination of their websites and white papers reveals no underlying business model or technology use case at all. Or if there is one, it makes no commercial sense. These projects will often ask that any paid featuring of their platform on media outlets appears as genuine editorial and should not be marked as paid or sponsored. Brave New Coin will never run paid editorial without disclosing it is sponsored, but numerous crypto media publications do.

The financial model of these nothing projects is that funds are spent on minting trillions (or quadrillions) of tokens, followed by maximum-hype marketing, well-designed websites and massive social media pushes.

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The end game for these tokens is a major exchange listing, at which time the founders will exit. Brave New Coin does not promote these types of projects.

How to spot a crypto pump and dump scheme

The easiest way to identify a pump and dump scheme is when an unknown coin suddenly rises substantially without a real reason to do so. This can be easily viewed on a coin’s price chart. Coincheckup, for example, has set a benchmark of a 5% price increase in less than five minutes as its indicator.

Also, when you see paid news articles about a small cap coin appearing in combination with a surge in social media activity surrounding that particular cryptocurrency project, this could be the sign of a pump taking place. If an entirely unknown coin with market capitalization of only a few million dollars suddenly appears all over Twitter and Facebook, one should be wary.

How to protect yourself from pump and dumps

Pump and dumps are generally confined to coins with very low trading volumes and market capitalizations. By avoiding illiquid cryptocurrencies, your chances of falling victim to a pump and dump are substantially reduced. Furthermore, not following investment advice on social media or from paid news articles will also prevent you from making preventable losses due to this type of market manipulation. You cannot be confident that crypto media organizations will have done any vetting of coins they feature, and as mentioned, oftentimes these articles are paid for but that payment is not disclosed.

A good rule of thumb is to remember that anyone promising that they know which crypto coin will pump next, likely has an ulterior motive.

A sudden jump in price without real verified news backing the increase is an indicator of a potential pump and dump scheme unfolding. Hence, if the price chart says a pump is underway, it is best to avoid the coin altogether unless you have done your research on the digital currency and its potential future value.

The BitcoinTalk forum is a good place to do some research, and Reddit can be a good source as well. In general terms the wider cryptocurrency community likes to self-regulate and call out fraudulent players who harm the community’s reputation. Contacting cryptocurrency projects directly and getting your questions answered is an even better way to research a coin before investing in it. Finally, independent research can also be used to make better investment decisions.

The CFTC will pay pump and dump whistleblowers

To combat the unfortunate phenomenon of pump and dump schemes in the cryptocurrency markets, the U.S. Commodity Futures Trading Commission has announced that it is offering financial incentives for whistleblowers who are involved in such pump and dump groups.

The CFTC published a consumer advisory statement warning investors of cryptocurrency pump and dump schemes. In the announcement, the CFTC advises “customers to avoid pump-and-dump schemes that can occur in thinly traded or new ‘alternative’ virtual currencies and digital coins or tokens. Customers should not purchase virtual currencies, digital coins, or tokens based on social media tips or sudden price spikes.”

In addition to its warning, the CFTC also informed consumers that they “could be eligible for a monetary award of between 10 percent and 30 percent” if members of pump and dump groups are able to provide original information that “leads to monetary sanctions of $1 million or more.” In other words, the CFTC wants to pay whistleblowers a reward if they can contribute valuable information that leads to finding the perpetrators behind such schemes.

The practice of paying whistleblowers is not new and already commonplace in the traditional financial markets (the SEC pays out hundreds of millions a year, for example). However, it was only in 2019 that U.S. regulators have also started to eye the cryptocurrency markets in this regard.