What are Pump and Dump schemes in cryptocurrency, and how can you protect yourself?

• Pump. This is the act of artificially inflating the price of a specific cryptocurrency. Typically, a coordinated group of traders will start buying large amounts of a low-value coin, causing its price to rise. The sharp increase in value creates the appearance of a promising investment.

• Dump. Once the price reaches a predetermined peak, the same group that inflated the price suddenly sells off their holdings, crashing the market. This leaves the late investors, who bought into the hype, with significant losses.

In essence, Pump and Dump schemes are designed to mislead investors into thinking that a cryptocurrency’s price is growing naturally when, in reality, it is being manipulated. The goal is to attract unwitting traders who will buy at an artificially high price, allowing the initiators to sell at a profit before the price plummets.

1. Selection of target. The perpetrators choose a low-volume or low-liquidity cryptocurrency, usually one that isn’t widely traded. Low liquidity ensures that even a small influx of money can create a significant spike in price.
   
   

2. Coordinated buying. The initiators, often organized via private online groups or forums, start buying the cryptocurrency in large amounts. The surge in buy orders pushes the price upward, often by hundreds or even thousands of percent.
   
   

3. Creating hype. As the price climbs, the initiators begin spreading rumors or positive news about the asset. This can happen through social media, influencer endorsements, or even fake news articles. The goal is to attract more attention and convince others to buy in.
   
   

4. Market momentum. At this point, regular traders notice the rising price and jump in, fearing they’ll miss out on profits if they don’t act quickly. This increased demand further drives the price upward, creating a self-fulfilling cycle.
   
   

5. Massive sell-off (The Dump). Once the price has risen to a desired level, the original group of buyers starts selling off their holdings. This flood of sell orders causes the price to drop sharply, often within minutes.
   
   

6. Panic selling. As the price plummets, other investors panic and try to sell their holdings to minimize losses. Unfortunately, by this time, the market is oversaturated with sellers, and the price collapses. The initiators walk away with their profits, while most other investors are left with worthless assets.

Pump and Dump schemes are particularly effective in the cryptocurrency market because of the lack of regulation and the anonymity involved. Unlike the stock market, where such practices are illegal and monitored, the crypto world still operates in a grey area, making it an ideal ground for manipulation.

• Short-term Pump and Dump. This type typically unfolds in a matter of hours. A low-value, low-liquidity cryptocurrency is chosen because it can be easily manipulated with minimal capital. The price is pumped quickly, sometimes within minutes, and then dumped just as fast. Investors who miss the brief window to sell are left with near-worthless assets.

• Long-term Pump and Dump. In this version, the scheme plays out over several days or even weeks. Larger cryptocurrencies, including those in the top 20 by market cap (such as Bitcoin or Ethereum), may be targeted. These schemes require more substantial capital to manipulate the price, but they also offer higher potential returns. Due to the increased visibility of these assets, more investors are drawn into the scam, making it potentially more profitable for the initiators.

Both types of Pump and Dump schemes are dangerous for uninformed traders. While the short-term schemes can devastate investors quickly, the long-term versions are particularly insidious, as they give the illusion of legitimacy, luring in more cautious traders before the inevitable crash.

1. Be skeptical of sudden price surges. If you see a cryptocurrency suddenly increase in value for no clear reason, take a step back. A price jump that isn't backed by legitimate news, developments, or increased adoption may be a sign of market manipulation.

2. Verify information from reliable sources. Always cross-check news and rumors from trusted sources before making investment decisions. Scammers often use social media and unverified news platforms to spread misinformation about a coin’s potential.

3. Stick to a trading strategy. Emotional trading, especially when influenced by FOMO, is one of the primary ways traders fall prey to these schemes. Stick to your strategy and only trade based on clear signals, not sudden market movements.

4. Manage your risk. Limit the amount of capital you allocate to speculative investments, particularly in lesser-known or low-volume cryptocurrencies. A good rule of thumb is to never risk more than 5% of your portfolio on a single trade. For highly speculative assets, this percentage should be even lower.

5. Avoid chasing the trend. If you notice a price rising quickly, resist the urge to jump in at the last minute. It’s often too late by the time most traders recognize the surge, and buying in could leave you holding the bag when the price crashes.

6. Be aware of the Pump and Dump lifecycle. Recognizing the pattern of these schemes can help you avoid them. If a cryptocurrency’s price skyrockets without a solid reason, it’s highly likely that a Pump and Dump is underway.

Taking a cautious and informed approach to cryptocurrency trading is the best way to avoid becoming a victim of these schemes. By staying disciplined and doing your homework, you can better protect your investments and increase your chances of success in the volatile world of crypto.