Pump and Dump in Cryptocurrencies

It is striking how cryptocurrencies are both similar and dissimilar to the more established asset classes at the same time. On the one hand, many findings from traditional asset classes also apply to this novel class. On the other hand, this “new” world with its own characteristics brings many novel “problems” that attract researchers. This week’s blog presents several research papers connected to the pump and dump schemes in cryptos. These pumps and dumps are nothing new, and we already know them from the stock market. However, there are some notable differences. In the stock market, manipulators tend to persuade other investors that they have private information and the stock is deeply undervalued. In cryptos, the situation is different. There are private and organized anonymous “pump” groups (using apps such as Telegram) where the administrators announce that at a given time and cryptocurrency exchange, they are gonna pump some (unknown to the public at that time) cryptocurrency. There is no claim that the crypto is undervalued, and it might appear purely speculative. This strategy allows for two key things: firstly, the manipulators can buy the cryptos in advance of the pump, allowing them to dump it to gain a profit, and secondly, other participants can transfer fund to the given exchange to be ready for the pump that is announced as the name of the crypto later. Moreover, the administrator might even offer “private” and paid information and might share the name of cryptocurrency in advance. As the research papers show, it is crucial to buy the currencies before the pump starts since the pumps are connected with negative expected returns.

With negative expected returns and the zero-sum game attribute of these pump and dump schemes, why would anyone want to participate in these speculations? According to the research, people are attracted to the gambling, excitement and expectations of big profits in a short time connected with these schemes. Additionally, they overestimate their abilities to time the pumps and dumps. People also might believe that they are the “fast” ones, and there would be slower buyers that will buy the crypto they are already dumping. 

The general insights are excellent examined in the papers of Li, Shin and Wang (2021) and Dhawan and Putniņš (2020). Furthermore, Xu and Livshits (2019) research paper even study the possibility to predict the pumps and dumps. Using various features such as market cap, multiple volumes and returns, number of previous pumps or some sort of crypto rating, authors try to predict pumps in future using random forests and generalized linear models. Although the prediction accuracy is far from perfect, it might be interesting to build on this research and dive deeper. Given the scarcity of regulations in crypto markets, such schemes can be only hardly eliminated.

Authors: Anirudh Dhawan and Tālis J. Putniņš

Title: A New Wolf in Town? Pump-and-Dump Manipulation in Cryptocurrency Markets

Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3670714


We show that cryptocurrency markets are plagued by pump-and-dump manipulation, with at least 355 cases in seven months. Unlike stock market manipulators, cryptocurrency manipulators openly declare their intentions to pump specific coins, rather than trying to deceive investors. Puzzlingly, people join in despite negative expected returns. In a simple framework, we demonstrate how overconfidence and gambling preferences can explain participation in these schemes and find strong empirical support for both mechanisms. Pumps generate extreme price distortions of 65% on average, abnormal trading volumes in the millions of dollars, and large wealth transfers between participants. These manipulation schemes are likely to persist as long as regulators and exchanges turn a blind eye.

Authors: Tao Li, Donghwa Shin and Baolian Wang

Title: Cryptocurrency Pump-and-Dump Schemes

Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3267041


Pump-and-dump schemes (P&Ds) are pervasive in the cryptocurrency market. We find that P&Ds lead to short-term bubbles featuring dramatic increases in prices, volume, and volatility. Prices peak within minutes and quick reversals follow. The evidence we document, including price run-ups before P&Ds start, implies significant wealth transfers between insiders and outsiders. Bittrex, a cryptocurrency exchange, banned P&Ds on November 24, 2017. Using a difference-in-differences approach, we provide causal evidence that P&Ds are detrimental to the liquidity and price of cryptocurrencies. We discuss potential mechanisms why outsiders are willing to participate and describe how our findings shed light on manipulation theories.

Authors: Jiahua Xu and Benjamin Livshits

Title: The Anatomy of a Cryptocurrency Pump-and-Dump Scheme

Link: https://www.usenix.org/conference/usenixsecurity19/presentation/xu-jiahua


While pump-and-dump schemes have attracted the attention of cryptocurrency observers and regulators alike, this paper represents the first detailed empirical query of pump-and-dump activities in cryptocurrency markets. We present a case study of a recent pump-and-dump event, investigate 412 pump-and-dump activities organized in Telegram channels from June 17, 2018 to February 26, 2019, and discover patterns in crypto-markets associated with pump-and-dump schemes. We then build a model that predicts the pump likelihood of all coins listed in a crypto-exchange prior to a pump. The model exhibits high precision as well as robustness, and can be used to create a simple, yet very effective trading strategy, which we empirically demonstrate can generate a return as high as 60% on small retail investments within a span of two and half months. The study provides a proof of concept for strategic crypto-trading and sheds light on the application of machine learning for crime detection.

As always we present several interesting figures and tables:

Li, Shin and Wang (2021)
Dhawan and Putniņš (2020)
Xu and Livshits (2019)
Xu and Livshits (2019)

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