Pumps and Dumps

The pump and dump, an age-old scheme to quickly raise the value of a worthless asset and then selling it to reap the profits from the price increase. Not only is the pump and dump illegally under the securities laws, but it is also extremely popular in the world of Blockchain technology, cryptocurrency, and digital assets.

How does it work?

In a pump and dump scheme, the price of a worthless asset-usually a penny stock with a low market cap-is artificially inflated through well-planned marketing. False statements, misleading statements, a large number of social media posts, co-signs, and other chicanery are used to get the word out that a worthless asset is actually a hot buy that investors do not want to miss out on (the pump).

To support these claims, the price of the worthless asset is increasing rapidly due to the well-planned pump. Once investors get word about the worthless asset and see its price rising rapidly, more investors start to buy up shares of the stock.

This is when individuals who are in on the pump and dump scheme will sell or “dump” the shares of the overvalued asset. These individuals profit from selling the asset at or near its peak for many times more than the price they purchased it at. When they begin to sell their shares of the overvalued asset, the price of the asset tanks and corrects to a more accurate and appropriate valuation.

Internet for pump and dumps

Before the invention of the Internet, pump and dumps were much harder to organize. Individuals had to organize pump and dumps in person, via telephone, or via snail mail. Pump and dump schemes were often organized by “Boiler Rooms,” outbound call centers that were known for using dishonest sales tactics like promoting penny stocks to turn a profit.

With the creation of the Internet, it became far easier to execute a pump and dump scheme. These days, individuals converse in chat rooms, via messaging apps, and on Internet message boards to coordinate a pump and dump. With all the venues that the Internet provides to converse with each other, the Commodities Futures Trading Commision (CFTC) has become wary that pump and dump schemes could even sway professional investors into taking on an amount of risk that they did not intend to undergo.

Regulations

As the market for cryptocurrency continues to grow, government organizations give the burgeoning market the attention that it needs to develop. This includes releasing detailed reports like the CFTC Primer on Virtual Currencies, holding hearings with Congress, and giving consumers all the available information they have to mitigate the chance that the consumer will be susceptible to fraud or manipulation.

Pump and dump schemes are illegal and considered securities fraud by the SEC. In most regulated markets like the London Stock Exchange and the New York Stock Exchange, they are illegal as well. The CTFC is even offering a 10-30 percent bounty for any pump and dump whistleblowers who are able to lead the CTFC to monetary sanctions of $1 mln or more.

However, pump and dump schemes aren’t illegal on cryptocurrency exchanges. Cryptocurrency exchanges are not regulated; there is no piece of the legislature about cryptocurrency exchanges. So even though a pump and dump is unethical, it is not officially illegal (yet).

Four CTFC warnings

Although the cryptocurrency industry is maturing and taking the necessary steps to merge with the traditional banking and finance system. Blockchain and cryptocurrency is still in its Wild West phase. Due to a lack of regulation and consumer protections in the cryptocurrency markets, there are still enough opportunities to pull off fraudulent and manipulative schemes like the pump and dump. That is why it is always better to do independent research of the assets you are interested in investing in, and to only take on an amount of risk that allows you to sleep comfortably at night.

To protect investors against manipulative markets, The CTFC’s advisory also gave consumers the following warnings:

·        Don’t purchase digital coins or tokens because of a single tip, especially if it comes over social media.

·        Don’t believe ads or websites that promise quick wealth by investing in certain digital coins or tokens.

·        Do not participate in pump-and-dump trades; market manipulation is against the law and many participants end up losing money.

·        There is no such thing as a guaranteed investment or trading strategy. If someone tells you there is no risk of losing  money, do not invest.