Watching Out for Pump and Dump Schemes: Things You Should Know

When an asset's price rises sharply (pump), followed by a sharp decline (dump), you can bet that scammers are using pump-and-and-dump tactics to their benefit. Cryptocurrency isn't the only asset that may be used in these methods, even stocks do too sometimes.

Most pump and dump strategies occur when a group of investors join an asset early and then get other investors to do the same in order to push the price further up. This causes a stock market meltdown because the initial investors "dump" much or all of their shares. It's possible for investors who weren't first in the game to suffer significant losses.

A crypto pump-and-dump scam works in much the same way. Let’s explore it in a bit more detail.

How Does It Work?

In a pump-and-dump strategy, the price of an asset is first raised, and then it is subsequently pushed down by a large-scale selloff.

During the initial phase, a group of developers or investors promotes a currency or spreads false information about it in order to encourage others to purchase it.

Think of a promise like this: "Buy this crypto and earn millions this month; it's going from $0.01 to $1.00 because it's so unique and amazing!" Memes depicting rocket ships flying to the moon with various cryptocurrencies on them are likely to follow. But as mentioned on crypto websites such as Bitcoin Up, “there are huge risks involved, as the market is extremely volatile.” Most of that volatility is user-generated, sometimes by pump-and-dump schemes. So, you should be wary of impressive promises that overlook all the relevant risk factors.

Meanwhile, the investors who are propagating the rumour have a big share of the coins that are now available for purchase. It's possible that the project's creators are the ones making these statements in order to start a pump-and-dump scheme.

The second step of a pump-and-dump scam occurs after enough crypto holders have been enticed to acquire the new coin. Thanks to the spike in demand, its value has been successfully driven up.

The initial investors begin selling their tokens after waiting for the price to climb to unreasonably high levels. As a result of this, the value of the asset drops dramatically, which may prompt others to sell as well. As a consequence, investors who wait until the last minute sometimes suffer substantial losses.

Is It Illegal?

Legally speaking, pump-and-dumps are not permitted in the stock market, but this is not always the case in the cryptocurrency market.

Pump-and-dumps are considered market manipulation by the Securities and Exchange Commission (SEC), and anybody found guilty of them would face legal action. However, since most cryptocurrencies aren't securities, they're not subject to the same regulations as traditional financial instruments like stocks and bonds.

Cryptocurrency "pump and dumps" may be ethically and legally dubious, but they may not violate any present laws.

As a result, anybody contemplating a crypto pump-and-dump should rethink their strategy. The Commodities Futures Trading Commission (CFTC) indicted computer entrepreneur John McAfee in March of 2021 for boosting cryptocurrencies on his Twitter account without revealing that he and his accomplices had already invested in the coins before he did so. His death came too soon to bring the matter to trial.

How Can You Spot Them?

Pump-and-dump schemes are difficult to identify; therefore, investors must do their own research and use their own best judgement when considering whether to buy a coin.

The most obvious sign of a pump-and-dump strategy is a cryptocurrency or project that has amassed an inordinate amount of buzz. Using phrases like "this crypto is the next great thing," "Bitcoin 2.0," or "Bitcoin 3.0" in a marketing email or social media post may indicate a pump and dump.

It may be a warning signal for prospective investors when there seems to be an unusual degree of excitement about a cryptocurrency for no apparent reason or for reasons that don't make sense.

Another sign of a pump-and-dump strategy is a sudden and steep surge in the price of a cryptocurrency. Even if the coin is well-known, it might still be overlooked, neglected, or forgotten.

When insiders' purchases coincide with good "news," it gives the impression that something huge is occurring. An increase in the number of prospective purchasers who are aware of what is occurring leads to an even greater increase in the price of a product.

An initial coin offering (ICO) is a kind of short-term pump-and-dump trading in which a new cryptocurrency is offered to the public. Initial investors begin to pay out once people get intoxicated by the promise of a project and bid up the price. Most people eventually move on to fresh ventures and resume the cycle.

The Risk

One of the riskiest investments an investor can make is trying to participate in a well-known pump-and-dump operation. Gains that seem too good to be true are often just that: fantasies.

A crypto pump-and-dump is almost always a possibility when investing in alternative cryptocurrencies. In many cases, the value of an asset has dropped by 90 per cent or more from its peak and will never return. Although this is improving as the cryptocurrency industry develops, many altcoins still have tiny enough market capitalisations to be easily manipulated.

With a market value of over $1 trillion, pump-and-dump schemes are far more difficult to carry off with Bitcoin. In order for a pump and dump to work, the asset must have little liquidity, which makes it simpler to produce large price movements. Market manipulation may occur in any financial market, although it is more likely to occur in the stock market.

Final Thoughts

It's not illegal for investors to pump up the price of a cryptocurrency, then dump it and push the price back down since there is some movement toward that end. Investors who participate in a Ponzi scheme are taking on one of the most dangerous bets they can make.

Pump-and-dumps have hit several cryptocurrencies throughout time, and although it's impossible to anticipate when one will occur, there are warning indicators to look out for.

Ensure that you have completed all of your required readings and assignments. In order to produce cryptocurrencies or tokens, one just needs a basic understanding of computer programming. If you're curious about a new currency that promises to make you wealthy, do some research online. The "white paper" of the initial coin offering, or ICO, will include information on the currency, its creators, and its goals.

Don't invest more than you're willing to lose if you're still interested in investing. Assume that the money you're spending to acquire tokens will be gone forever, and you'll have a greater chance of profiting from a pump and dump.
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