Beware the wolf of cryptocurrency markets

Cryptocurrency markets are plagued by price manipulation, with more than 350 cases of “pump and dump” scams uncovered over a seven month period on two cryptocurrency exchanges, new research reveals.

The study, by finance professor Talis Putnins and PhD researcher Anirudh Dhawan from UTS Business School, highlights how these scams are enacted “in broad daylight” in the $2 trillion cryptocurrency market with regulators and exchanges turning a blind eye.

In a pump and dump scheme, manipulators openly declare their intention to pump the price of a specific cryptocurrency, and encourage thousands of followers on social media or encrypted message apps to buy the coin.

Pumps generate extreme price distortions of 65% on average, and abnormal trading volumes in the millions of dollars, the study found. Once the price is inflated, the manipulators then “dump” the overvalued cryptocurrency, the price falls and many investors lose their money.

“Cryptocurrency manipulators typically do not seek to trick people – they explicitly communicate that a coin is being pumped,” Professor Putnins said, “that’s what makes it different to traditional market manipulation.”

“Pump participants then compete to buy a pumped coin ahead of others and sell out near the peak, however they overestimate their speed or skill compared to others.”

Currently, a lack of regulation and enforcement, as well as weak or absent oversight from exchanges, allows this form of manipulation to persist and flourish.

Professor Talis Putnins

On average, it takes about eight minutes for a pumped coin to reach its peak price, after which the dumping phase commences and the price collapses. The researchers conclude that these schemes are, to a large extent, a type of trading game that attracts people looking for a gamble.

“Gambling propensity increases during times of anxiety, isolation, and boredom,” Professor Putnins told the Australian Financial Review. “It explains why these games are really popular. They’re a form of manipulation unlike any we’ve seen in traditional markets.”

Wealth is transferred from the slow and overconfident players to the manipulators and faster, more sophisticated players. The researchers estimate that manipulators make a profit of $US 6 million per pump.

Despite the finding that many pump participants treat it as a form of game or gambling, cryptocurrency pump-and-dumps nevertheless constitute market manipulation as they involve the intention to influence the price of a traded security.

“Currently, a lack of regulation and enforcement, as well as weak or absent oversight from exchanges, allows this form of manipulation to persist and flourish,” said Professor Putnins.

“If left unchecked, widespread manipulation can damage the integrity of cryptocurrency markets, and reduce investor confidence in these markets and in the technology more broadly.”

The pre-print paper: A new wolf in town? Pump-and-dump manipulation in cryptocurrency markets is available on SSRN.