New Research unveils how pump and dump schemes work in crypto industry

A new research paper from the University of Technology in Syndey found that pump and dump schemes are rife in the crypto markets, having recorded at least 355 market manipulations in the seven months. Up to 23 million people participated in the schemes.

These pump and dump schemes, however, are almost nothing like the ones that have plagued the stock market for decades—everyone in the crypto market seems blatantly aware of what they’re doing.

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A peculiar form of pump and dump schemes formed in the crypto industry

While it’s undeniable that the cryptocurrency market has become too big to be ignored both by governments and large institutions, some of its aspects are still a thorn in the eye of many regulators.

The most common type of market manipulation seen in the cryptocurrency space are pump and dump schemes. Most commonly associated with the traditional stock market, pump and dump schemes are a manipulation technique in which traders take long positions in securities and then artificially inflate or pump their price before unloading their positions at inflated prices.

In their paper titled “A new wolf in town: Pump and dump manipulation in cryptocurrency markets,” Anirudh Dhawan and Talis J. Putniņš found that the manipulations seen in the crypto industry differ from those seen in the stock market in one crucial factor—the awareness of its participants.

According to the paper, the most important difference is that in cryptocurrency pumps and dumps, the manipulators make no pretense of having private information about a specific token being undervalued. In a conventional pump and dump scheme, manipulators try to convince investors to buy stock by spreading either false or hugely inflated positive news about the stock in a bid to get investors to buy.

Instead, cryptocurrency pump and dump schemes are openly discussed in Telegram or Discord groups, and “pump signals” on any given coin are publicly declared.

“Cryptocurrency manipulators typically do not seek to trick people into believing that a coin is mispriced on the basis of fundamentals—they explicitly communicate to the pump group members that a coin is being pumped, as opposed to representing a great investment opportunity.”

While this might not sound uncommon to the more experienced traders, it’s a relatively novel feature in financial markets. It also raises two very interesting questions the researchers tried to answer in the research:

First, why does anyone participate in these pumps, and second, how are manipulators able to profit if they aren’t fooling any of the other participants?

A risky game for overconfident traders and gamblers

As pumps provide negative expected returns for anyone after than the manipulator, the research concluded that rational individuals don’t participate in pump and dump schemes.

There are, however, two specific types of traders that participate in such schemes.

According to the paper, the first type are overconfident traders that overestimate their ability to sell their tokens at the highest price. The second are gambles.

Overconfident individuals that believe they are more skilled than the average crypto trader usually expect to enter and exit pumps faster than everyone else. This is such a widespread occurrence in the market that, when considering enough parameters, it is possible to calculate the expected payoff of a pump for an overconfident individual. Another interesting finding is that overconfident traders tend to prefer less liquid coins when engaging in pump and dump schemes.

Unlike overconfident traders, the second major group that participates in pumps and dumps doesn’t see this type of market manipulation as a one-time payoff opportunity. Gamblers tend to have a preference for “lottery-like” assets—they don’t participate in a single pump and dump, but in a series of schemes that collectively constitute a game.

The mechanics of a pump and dump scheme

To uncover cases of market manipulation in the crypto market, the researchers dug deep into chat history data from Telegram pump and dump channels to find cases where the administrator pre-specified a date, time, and exchange for the pump. After cross-referencing that with pump data from Binance and Yobit, the researchers identified 355 pumps that occurred in the period between December 2017 and June 2018.

In the seven months, there were 1,307 cryptocurrencies traded on the two exchanges. However, as the researchers were only able to gather all of the necessary data for 197 coins, they concluded that around 15 percent of all coins experienced at least one pump and dump manipulation during that time. In reality, this number could be closer to 30 percent.

Nonetheless, the numbers show that pump and dump manipulation is widespread and frequent.

Volumes traded during these pump and dump episodes are also economically meaningful—the report found that around $350 million was traded during the 355 pumps in the paper’s sample.

An example of an almost perfectly executed pump and dump scheme was ChatCoin (CHAT). The pump, according to the research, was run on the ‘Big Pump Sigal’ (BPS) group on Telegram. With its 63,000 members, the group is filled with manipulators orchestrating pumps and traders eager to turn a profit.

The administrators of the group announced the exchange, data, and time at which the pump will occur, but not the actual coin that will be pumped. Announcements like this allowed the participants of the pump to prepare for the trade by transferring funds to the exchange and be online and waiting for the so-called “pump signal.”

The signal, in this case, was the announcement of the coin being pumped. Signals are usually published through images, as shown in the screengrab above, to prevent the messages from being automatically flagged.

The price movement for ChatCoin before and after the pump signal backed up the claim that pumps usually targeted low-liquidity cryptocurrencies. While the graph below doesn’t go farther than 15 minutes before the sign, CHAT’s price was on the low end of the spectrum and relatively stable for days at around $0.06. The pump signal, given at 20:00 GMT on Jun. 10, 2018, caused CHAT to go parabolic and peak at just over $0.09 around 17 seconds after the pump signal.

The importance of market manipulation research

While taking up the resources to conduct research as extensive as this might seem futile to some, the current market conditions just highlight its importance. Anirudh Dhawan, one of the authors of the paper, told CryptoSlate that studying these schemes is vital because they harm the reputation and integrity of the entire crypto market:

“Institutions are likely to stay away from these markets, and regulators are likely to use this manipulation activity as a reason to block moves to expand the markets—as the SEC did in the case of Bitcoin ETFs.

Aside from that, these kinds of schemes provide a useful dataset to examine market manipulation. Dhawan told us that you don’t typically see market manipulation happen in the open, as is the case with crypto pumps and dumps, making them a rare opportunity to study a relatively frequent phenomenon in the financial markets.

“Our aims with this research project were to bring such kinds of manipulation schemes to light and examine why people participate in these schemes in the first place,” he said.

The research could act as a useful base both for companies in the crypto industry and government entities looking to regulate them. Currently, a lack of both regulation and its enforcement allows this type of manipulation to persist and flourish. Such widespread manipulation ultimately leads to a loss of confidence in the crypto market, which, in turn, impedes its growth.

The only thing left to do is find the right balance between and enforce regulations that facilitate a safe and healthy market without suffocating it.

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