Pump and dump schemes are the province of penny stocks and cryptocurrencies because they trade on mostly unregulated exchanges. Penny stocks trading on the big boards are rarely susceptible to these kinds of manipulations because the SEC is very aggressive about seeking them out and punishing the culprits.
In a crypto pump and dump, an inner core of investors identifies a low-volume coin on a small exchange and lock up its liquidity. Then they bring others into the scheme to shill for the coin on Reddit, Facebook, Twitter, Telegram, and in chat rooms to get unsuspecting investors to buy in. Once everything is in place, the schemers buy in concert, driving up the crypto’s price. This, of course, triggers casual and inexperienced investors to ride the green wave.
Once the coin reaches a target price, those in on the scam quickly sell off all their coins. The casual buyers are left holding a pile of artificially inflated currency that soon becomes virtually worthless.
The Wall Street Journal analyzed six months of cryptocurrency trading in 2018 and discovered 175 pump and dumps involving some 120 coins, resulting in hundreds of millions in losses for the victims. The largest and most successful of the pump-and-dump teams initiated 26 operations worth over $222 million in trades during that period.
The scams usually follow on the heels of an ICO, and ICOs have increased exponentially over the past year. Between 2014 and 2016, ICOs raised about $300 million. In the 18 months between January 2017 and July 2018, ICOs raised $20 billion.
The problem with trading in crypto or penny stocks is that double and even triple-digit price swings are common, and that appeals to inexperienced and/or greedy traders’ dreams of scoring a huge win. And average or inexperienced traders have a very hard time distinguishing between a legitimate rise in price from the beginnings of a pump and dump scheme. This is especially true in the crypto world, where price swings happen, and fortunes are made and lost in the blink of an eye.
The Journal story highlighted cloakcoin, an obscure crypto targeted by a pump scheme. Word went out on various communications channels to buy cloakcoin at 3 pm on Binance on a particular day. Although there had been virtually no trading on the currency prior to that day, over 6,700 trades worth $1.7 million took place in a matter of minutes, sending prices up over 50%, before plummeting a few moments later.
The point for traders interested in crypto or penny stocks is that there is no substitute for doing your own research. You have to be vigilant about watching the signals on social media that a currency or stock is being groomed for a pump and dump scheme. As always, if something looks too good to be true, it probably is.
Until the smaller exchanges come under a reputable regulating body, crypto and penny stock will remain susceptible to manipulation. It’s up to each trader to become knowledgeable about the coins and stocks he’s thinking of buying, and to resist the instinct to miss out on “the next big thing” unless research and due diligence supports the hype.