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Pump-and-Dump Schemes | How It Works? | Notum

By Notum

Feb 11, 20224 min read



Pump-and-dump scams have existed for ages since the market for securities. 

There is a way to avoid a pump-and-dump scheme in the stock market: to focus on stocks traded on popular, well-known exchanges. Why is it so? The matter is that such exchanges have strict listing requirements, and they don't let pump-and-dump schemes in. While you're sticking with well-known and widely adopted cryptocurrencies such as Bitcoin (BTC) and Ethereum (ETH) and well-known exchanges like Coinbase and Binance, you are out of trouble. Most exchanges openly show you all the orders for an asset and the order history. It's also a wire fraud because cheaters communicate with their victims via email, direct messaging, social media, or phone calls to pump the stock.

A Pump and Dump scheme is a stock market hoax involving artificial inflation (called "pumping") of a stock price with fake, misleading, or bubbled statements about the price. Those who started such crypto gossiping can benefit from inflating the price by quickly selling the assets at a high price (called "dump").

Simultaneously, the new stock owner will probably lose a significant portion of their capital, as the stock price will fall speedily. These schemes usually focus on small-capitalization stocks, as it is much easier to manipulate and do not need many new buyers to drive a stock up.

It is an illegal scheme under securities law and can cause those fraudsters to pay huge fines. As it's said in The Securities Act of 1933: "to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact." 

The bad news is that it's perfectly working for regular stocks but has yet to be implemented in the cryptocurrency field. 

How Does the Scheme Work? 

Pump and Dump schemes were made through cold calling. But since we have the Internet, these illegal scams went even further and are carried out via email, spam, and fake news.

As a rule, bad actors post messages online asking investors to buy shares quickly, assuring that they have inside information about an upcoming increase in share price. Once buyers swallow the bait, the scammers immediately sell their assets, causing the price to fall rapidly and newly backed investors to lose money.

Types of the Pumps-and-Dumps

  • Pump and Dump ‘classic’ scheme

The scheme is about the manipulation of information about a company and its actions. It can involve phone calling stock presentations, fake press releases and the spread of some type of “internal” information that can blow up the assets price, attracting investors’ attention to buy them.

  • Boiler room pump and dump scheme

A boiler room stands for a small brokerage firm that has some brokers who use dishonest sales schemes to sell doubtful investments to investors. 

Those dishonest brokers sell penny stocks that the company buys or sells as a market maker via cold calls. Brokers who work in the Boiler Room must sell as many shares as possible to increase their stock. As soon as the price rises, the company sells its stock for a benefit.

  • A “Wrong Number” scheme

This one is fairly new, and it is processed through sending voice messages to people with investment advice to a “friend.” Once the person who gets the message believes that it came to him by pure accident, they could fall into the trap by investing in that stock following the suggestion.

How to Avoid All Those Schemes

As they say, forewarned is forearmed. So, how to avoid all those schemes mentioned above? 

First, don't neglect the DYOR concept, as there is no difficulty in minting new tokens for those who understand coding. If there turned up a fresh coin promising you Lambo, do thorough research that will protect you from pump-and-dump scams. If it's an ICO (the initial coin offering), it should have a "white paper" with many details about the coin. 

Don't FOMO; cryptocurrency is still poignant but fragile — there are loads of scammers everywhere, and they know you desperately want to earn some money. That's why those bad actors are using a special approach that is contributing to your decision on whether to invest in a cryptocurrency. 

You can find scammers even in your favorite communication channels such as Discord, Twitter, Instagram, Telegram, etc. be aware of people who start hyping up a freshly minted token, with a high probability they're promoting a scam. 

Be careful with crypto influencers who you follow who hardly mention cryptocurrency and all of a sudden begin advertising a token. If you need financial advice, find a real professional. 

If the token is around but the project’s development seems to have disappeared, it's better to avoid it. If the project has no clear purpose, it purports benefits that seem unrealistic, its development roadmap isn't well thought out, or it's associated with previous bad actors, those are all red flags, too.

Last, don't forget a golden rule saying — "Don't invest more than you're willing to lose." You have to face the fact that once you make an investment mistake, you'll lose your assets forever. 

Closing Thoughts

So, there is nothing new and unusual about fraud and its derivatives, but you must be empowered with knowledge. 

Follow the tips we shared with you here, and then with almost 100% confidence you can stay away from pump-and-dump schemes that are multiplying around.