Pump and dump of trade is a phenomenon that is not only synonymous with cryptocurrency but has been in existence for a long period even before the advent of cryptocurrency. Despite its age-long prevalence in stock, forex among others, there is a constant opinion that it is a bad act. Lending voice to the inherent evil that the malicious act has led three academics to analyze how it is done and the dangers.
Cryptocurrency Pump And Dump
Just like pump and dump in other fields, cryptocurrency pump and dump undergoes the same procedure. A premeditated plan by some malicious persons as noted in the academic work of Tao Li, Donghwa Shin, and Baolian Wang, two from the University of Florida and one from Princeton are noted to be detrimental to the liquidity and price of cryptocurrencies.
The content of their paper indicated the ongoing malicious act at Yobit exchange, where the management openly proclaimed that it would be
injecting tons of money into random coin on its platform to inflate the price. The step is similar to a pump and dump scheme.
A pump and dump scheme is a premeditated and conspiracy of some set of individuals to inflate the value of a particular commodity or coin via an influx of money at an agreed time. This will create a sudden surge in the value of the coin and will lead to further increase with many investors also trying to invest speculatively hoping for a further increase. While this is on, the architects of the pump, which is an increase in price sell off their crypto holdings at a higher price. This causes a dump and put the investors that purchase the coin at a higher price at the wrong end because the rise might not take place again.
Trading amid pump and dump scheme is like getting caught up in a building victimized by an arsonist. In this case, the arsonist is bound to escape with no evidence of smoke to his lung, if he gets burned at all. Meanwhile, the rest of the people suffer in various degree while the last suffers most.
The Secret Scheme
The academic work noted that the market manipulators usually organize pump groups through the use of an encrypted messaging app such as telegram. They create group channels and invite others to join and advertise on social media for other members to read. For actualizing a scheme, the operators announce the target date, time and the exchange a day in advance. However, they do not disclose the token until the scheduled time.
Also, the most successful schemes happen at the launch of a token or coin and are perpetuated by the creator or the team, as a whole blockchain could be abandoned for the pursuit of a small number of bitcoins.
Cryptocurrency exchanges need to take considerable efforts in curbing the prominence of this on their platforms like the step taken by Bittrex. In similar fashion to gambling, new entrants into crypto trading often lose their investment due to pump and dump scheme.