What does it mean?
In the context of cryptocurrencies, the expression Pump and Dump has no negative meaning. It literally indicates the growth and contraction of the market.
What is it?
The Pump and Dump scheme is a type of investment scam where a whale investor or a group of investors forcefully promote a cryptocurrency in their possession to artificially inflate the price and then sell it for profit. A Pump and Dump scheme can be performed through fake news or large transactions between two or more malicious users who create within the market the false illusion that the value of that cryptocurrency is growing, inducing small investors to buy it. But once the promoters of the scam sell, the price collapses and the small investors lose their invested capital, because they find themselves with a suddenly worthless currency.
The Pump and Dump is an absolutely illegal operation but it was not born in the world of cryptocurrency. It is, in fact, a tactic derived from the world of traditional finance, which has taken advantage of the hyperbolic growth of the crypto market to proliferate and cause huge damage to small investors. Moreover, the cryptocurrency markets are still poorly regulated, representing an ideal breeding ground for these unfair players, who do not risk legal consequences, as would happen if they tried to do so with traditional financial instruments.
How the Pump and Dump works
The Pump&Dump is always carried out with the same pattern, independent of the type of cryptocurrency, the parties involved or the chosen market. The three phases are:
- The Pump Phase
- The Dump Phase
In the accumulation phase, scammers secretly buy huge quantities of a specific cryptocurrency at a relatively low price. Purchases are diluted over several weeks to avoid suspicion. The chosen cryptocurrency is often an unpopular currency with a small market capitalisation because the price is so low that it makes it much easier and profitable to artificially manipulate the price and inflate its value.
Once this phase is over, the real scam begins: pumping the price. There are several techniques to stimulate the interest and entice uninformed or simply naive investors to buy the cryptocurrency subject to the Pump and Dump. One of these is to pretend to be experts in the sector, to position oneself as holders of confidential information, to spread fictitious market forecasts through newsletters, Telegram groups of enthusiasts, spreading fake news on social networks with the aim of generating hype and spreading false signals of a bull market (upwards).
If the fake news campaign is successful and a fairly large number of people start buying that cryptocurrency, a snowball effect occurs. The sudden increase in demand leads to a price surge so that more and more people believe to see an easy and fast chance of earning money, thus buying the currency and generating a further swelling of its price.
As soon as the price is sufficiently “pumped”, all the scammers resell their coins within a few minutes. Since they hold large quantities of them, the new introduction of liquidity on the market generates a sudden and lethal collapse of the price, causing serious losses to new investors. The Dump is an action that takes place in a coordinated manner and in a very short time, so investors do not have the time to react and sell their holdings. When they realize that they have been victims of a Pump and Dump, it is too late.
How can I protect myself from the Pump and Dump?
The simplest strategy is to invest in cryptocurrencies that have passed the test of time and have a fairly large market capitalisation. It is true that often the highest profit margins can be made on smaller currencies, which are still growing and have proven to have high chances of staying in the market (because, for instance, they are the result of a strong project). But they are the same ones that, as mentioned in the previous paragraphs, are easier to manipulate in the case of a Pump and Dump.
What you can do if you decide to invest in a smaller cryptocurrency is to make some preliminary analysis that can help you avoid falling into a Pump and Dump scheme.
- Collect as much information as possible on the market value of the cryptocurrency you have chosen and its potential return, by observing the price trend in the previous weeks.
- To invest, don’t just rely on the media buzz. Look for reliable sources, do some research, try to understand if the price increase of that currency is related to significant external events (for example, the entry of a multinational as a partner in the crypto project which involves the cryptocurrency you are going to invest in, this is certainly the type of event that indirectly causes an increase in value).
- Use stop-loss orders. If you are making a long-term investment, price fluctuations, even if caused by a Pump and Dump, do not have to worry you. If you are looking for a quick investment, to set a stop-loss order is necessary.
A stop-loss order is a tool designed to limit an investor’s exposure to sudden price fluctuations. For example, setting a stop-loss of 10% on a cryptocurrency means that your holdings will self-liquidate if the currency suffers a sudden drop in value of 10% (dump). This way, when scammers start dumping their currencies and the price starts to fall, you have set up a reliable security measure to limit your losses.