Crypto “Pump-and-Dumps”: Buyer Beware
Given recent developments aiding the overall growth and scope of investment into the cryptocurrency market, all signs appear to be pointing towards digital assets playing an increasingly pivotal role in the global financial system in the years to come. Today it is becoming all the more common for experienced hedge fund investors and novice “Robinhood” traders alike to own a slice of Bitcoin and other altcoins, with the practice becoming nearly as commonplace as owning various individual stocks. Yet what the latter may fail to identify is the fact that unlike the stock market, protections and regulations surrounding the crypto-realm remain few and far between – this despite the exponential growth of the market over the past decade. This presents challenges and potential risks to those delving into the market for the first time with hopes of simply riding the wave of gains that have become widely publicized over the past year or so. Much like other crimes of the white-collar variety, it appears that the crypto market is too susceptible to efforts by fraudsters seeking to profit at the expense of unsuspecting citizens.
Whenever novel opportunities such as those presented by new or emerging markets come about, you can rest assured that financial criminals will be working their way towards taking advantage of potential loopholes or the general lack of clarity that often accompany these outlets. With respect to cryptocurrencies, the lack of legislation governing potentially illicit activity across the market is virtually non-existent which has enabled criminals to act with little to no fear of potential repercussion. A growing form of unethical activity that has hit both the crypto and U.S. stock market (the latter due in large part to the IPO craze seen since the onset of the COVID pandemic) are known as “pump and dump” schemes. These ploys involve the mass promotion and subsequent hype generation of a certain commodity or cryptocurrency by influencers (which can include celebrities, widely recognized investors/businessmen, or even ho-hum traders who have used platforms such as Twitter to build a strong following) which ultimately causes the coin/stock’s perceived valuation as a worthwhile investment to increase. More often than not however, this sharp increase in price point lacks a fundamental backing. This promotion then generally leads to major investment from the audiences targeted by those “pumping” these assets. Once the value of the stock/coin increases to a point deemed suitable by the promoter/scammer (i.e. reaching new all-time highs), they will then proceed to sell off all of their shares/coins and make substantial profits. Naturally this causes stock or crypto prices to drop quickly, leaving common investors following the hype train hung out to dry. The practice has already made millionaires of many while bankrupting far more. Arguably the two top cryptocurrency options on the market today, Bitcoin and Ethereum, have larger markets that are more difficult for even the most powerful to manipulate. However, billionaire entrepreneur Elon Musk had come under fire in recent months for doing just that. Earlier this year, word of the reported $1.5 billion investment made by Musk’s brainchild Tesla into Bitcoin spread like wildfire across social media (as well as his personal investment in what was at the time nothing more than a “joke-coin” in Dogecoin). Naturally, the prices of each of these coins surged “to the moon” as they say. However, much of the fun stopped in April as Musk abruptly had a change of heart about Bitcoin given “environmental” concerns with respect to the increasing use of fossil fuels for mining of the coin, proceeding to cash out to boost Tesla’s quarterly revenue – this at the expense of those rushing into Bitcoin investment off of Musk’s initial endorsement alone. Given that the number of alternative coins grows on a daily basis (and are essentially the equivalent of penny stocks), scammers have realized that you don’t need to be Elon Musk to make a profit via similar means in this space.
If the retail v. hedge fund (Gamestop) saga of spring 2021 taught us nothing more, it is that investors seeking to make quick profits can be easily manipulated with tactics as simple as a Reddit or Twitter post. And when someone has thousands of dollars invested in a coin worth <$0.50, it takes only a modest number of new investors to drive up the price, making the potential profits more than worthwhile for scammers. Making matters all the more pressing is the fact that these ploys are growing in prevalence at a very fast pace. CNet writes that “A 2020 study from the University of Technology Sydney and the Stockholm School of Economics in Riga found 355 instances of crypto pump-and-dump scams over the course of seven months” with the organizers of these scams walking away with millions of dollars.1 Many people casually invested in cryptocurrencies have no idea that the U.S. Securities and Exchange Commission (SEC) nor the Commodity Futures Trading Commission (CFTC) regulates cryptocurrency markets like they do stocks. If this type of activity were to occur in the stock market, it would be subjected to a full-fledged investigation and likely legal/criminal action. However, with no regulatory bodies in place to harbor the crypto market, this already volatile market has been viewed as the “Wild West” of the investment world. However, politicians are finally coming around to address this and other threats posed to the growing crypto-investor pool. Senator Elizabeth Warren (D-MA) has been advocating that a new coordinated strategy to better combat systemic risks posed to the U.S. financial system come from the U.S. Treasury Department. With a total of over 2,000 digital currencies at an estimated total market value approaching $2 trillion, there is a significant amount of unregulated currency floating around. “FSOC should review this matter and determine whether it is appropriate to utilize its statutory authority to contain the systemic risks posed by the growing cryptocurrency market,” she said. “The longer that the United States waits to adapt the proper regulatory regime for these assets, the more likely they will become so intertwined in our financial system that there could be potentially serious consequences if this market comes under stress.”2 It remains to be seen whether new Treasury Secretary Janet Yellen is up to the task and can react urgently to address this issue, though it is evident that regulation of some sort should be on the table in the coming months to maintain the integrity of U.S. financial sector.
Citations
1. Gonzalez, Oscar. “Cryptocurrency Pump-and-Dump Schemes: Everything You Should Know.” CNET, CNET, 27 July 2021.
2. Mejdrich, Kellie. “Warren Urges Yellen to Crack down on