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How can you lose money through pump and dump schemes?

15:58, 31 January 2022

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Pump and dump scams are hard to identify - Photo: Shutterstock

If you suffer from FOMO (fear of missing out) and enjoy getting crypto and stock tips on social media, you could be in danger of falling victim to a scam referred to as a “pump and dump” scheme.

Pump and dump schemes are not a new tactic, but they have recently made headlines following allegations that influencer Kim Kardashian and other celebrities were somehow involved in one.

Kardashian, as well as Floyd Mayweather Jr and Paul Pierce, are currently being sued by EthereumMax crypto-currency investors who claim the celebs worked with EthereumMax to “misleadingly promote and sell” the digital currency.

What is a pump and dump?

EthereumMax (which has no links to Ethereum itself) is not the only cryptocurrency where claims of pump and dump have been made. Just a few years ago, Capital.com wrote about how some in the crypto community were convinced that XRP and Ripple were a scam.

According to Adam Morris, co-founder of Crypto Head, “In the world of cryptocurrency, pump and dump schemes are when an investor or group of investors will spread false or misleading information about their coin or one they hold a large stake in, to convince unsuspecting investors to buy into the coin skyrocketing the price of it.”

Morris added, “Once the coin is effectively ‘pumped’, the originators of the scam will sell or ‘dump’ their coins whilst people are still buying it, making large profits but also creating substantial losses for all those defrauded.”

Hard to identify

These schemes are hard to identify as the information could be all over, even in legitimate sources. The false or misleading information is often spread via social media, online adverts, emails, market research websites and magazines.

They’re often hooked onto the latest craze. Last year, for instance, a successful pump and dump scheme was initiated on the back of the hype surrounding the Netflix show Squid Game.

Evan Spicer, director of cryptocurrency investigations at MyChargeBack explained, “A group of scammers started to pump up an otherwise unremarkable (and unconnected) coin called "$SQUID.”

“Its value jumped from a single cent to $2,800 before they bailed out and sold theirs to hungry investors looking to jump on the moving train. The scammers took in something like $2m while everyone else who bought into it during the pump stages were left with virtually nothing.”

Celebrities often used

To add “credibility” to these scams, the fraudsters often get celebrities to endorse various investments knowingly or unknowingly.

Spicer said, “It may not come as a surprise, but some celebrities are naive. Others can be manipulated like anyone else and many more can be impersonated. Even the pope has been impersonated in a crypto scam!”

These types of scams do not always apply to cryptocurrencies. “Pump and dump schemes also target micro- and small-cap stocks and over-the-counter exchanges that are less regulated than traditional exchanges,” said Dr Pooja Lekhi, professor of global financial institutions – risk management approach and financial management at University Canada West, in British Columbia, Canada.

“These stocks are easier to manipulate as they generally have a small float, low trading volumes and limited corporate information. As a result, it does not take a lot of new buyers to push a stock much higher,” said Lekhi.

Common tactics

While it can be hard to identify a pump and dump scam, Kay Khemani, managing director at Spectre.ai points out there are some common tactics are used by such fraudsters.

“The hallmarks of a rug pull typically involve broken communications or language barriers, an excessive focus on price targets in team interactions, and most commonly, promises of huge gains in very short time periods,” said Khemani.

“Among the most pronounced red flags to look out for is the lack of any tangible product, which should take a few months, if not years, to develop.”

How to avoid pump and dump scams

While they can be hard to identify, it’s not impossible to prevent yourself from falling for such a scam.

One of the best ways of doing this is to not give in to the FOMO. Adam Nasli, head analyst at BrokerChooser said, “There can be a huge pressure in the crypto community to jump on opportunities as quickly as possible, but you should always take your time to do research.

“Never feel obliged to invest in something because it's what everyone else is doing. If, all of a sudden, an influential person starts hyping up a new token, there is a good chance it’s a scam.”

Do your homework

As with any investment, it’s also important to do your homework thoroughly before parting with your money.

“Learn to spot the red flags of investment fraud. Make sure you are watching the market, get clued up on the information that is being put out there and validate it through several sources, such as a whitepaper or a website of the new crypto project. Lacking a website or whitepaper are red flags,” said Nasli.

Finally, don’t get taken in by what celebrities say or endorse. “Don’t take financial advice from celebrities such as Kim Kardashian or Floyd Mayweather. Both figures did not come into the public eye due to their expertise in finance or investing,” said Morris.

“Scammers are so successful because they use recognisable and trusted names to gain people’s trust into believing it is a good investment when in many cases these names have no association with the coin at all,” said Morris.

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