In investment circles there are several elaborate methods with which scammers try to exploit unsuspecting traders. This article exposes one such method that is frequently used in unregulated investment markets, such as the cryptocurrency market – the pump and dump scheme.
In so many words, pump and dump is an investment scam where scammers buy an inexpensive coin by market cap, advertise (or pump) it, and then sell (or dump) it once the price has risen. The inflation of the price doesn’t reflect the coin’s underlying value, which means that the price plummets once the dumping is done.
The pump and dump scheme begins with scammers selecting a viable cryptocurrency to exploit or even creating a coin related to current trends. It is ideally a little-known or fresh-on-the-market cryptocurrency (usually referred to as an altcoin) with a small market cap and which the general public does not know well (or at all). Such a coin has poor liquidity – low trading volume and meager supply and demand – meaning that very few people are buying or selling it. Once an appropriate candidate is selected, the scammers purchase a large quantity of the coins. This is often coordinated in anonymous and private online chat groups. The hype phase of such pump and dump scheme can also indicate an upcoming rug pull, as the creators drive up the price to cash out.
The increase in demand spurred on by the purchases of the scammers does part of the job to inflate the price of the altcoin. To hype the coin even more, scammers aggressively promote it across social media and communication platforms. Endorsement by public personas or institutions, whether real or (as can happen) faked by the scammers, also plays an important role in the buildup of the currency.
“Whale manipulation” is an alternative pumping strategy. Instead of just promoting the altcoin, the investor makes a substantial purchase to increase its trading volume and price through their own actions. This surge functions as additional bait for the unsuspecting trader.
Now the scammers only need to rely on the greedy nature of human beings. Effortless profit sounds like a good deal, so when people see an obscure coin rapidly growing in price, they are likely to want to hop onto the charging bull. This process, termed as fear of missing out or FOMO, is well-known in investment circles. It is the basic principle that makes pump and dump work.
Once a large enough number of external investors take the bait and the hype starts dying out, it’s time for the scammers to sell what they own. The currency has reached the point where the scammers believe that its selling price is at the maximum. The scammers then sell their coins at the inflated price and pocket a hefty profit.
The increase in supply and the drop in demand that follows start to decrease the falsely-inflated price swiftly. Dumping a sizeable amount by the scammers sends the altcoin’s price plummeting. Seeing the downward spiral and recognizing that the currency has no inherent value, external investors want to sell, too, to minimize losses. But for them, it’s already too late. Everyone who missed “dump o’clock” will likely end up with worthless coins.
Pump and dump schemes are not easy to recognize. Patterns on trading charts make no distinction between a pumped coin and a coin for which the increase in price is genuine. If purchasing coins at ICO or investing into obscure altcoins, you always need to research or ask someone with higher experience and only trade what you understand.
When investing, pay attention to exceptional price jumps (everything above 80% in a day or two is usually considered suspicious) and be careful with small-market-cap cryptocurrencies. If your research on the crypto yields no good reason for the price surge, that’s often simply because there is none. Steer clear. Your investments are better placed elsewhere. To avoid the rug pull, look for liquidity and lockups in a token pool. If they seem small, it's best to give the new token some time before investing.
If you want a safe cryptocurrency to invest in, you’re better off by selecting one of the largest cryptocurrencies around. (Source)