Pump and Dump’ scheme: what it is and how it works

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What is a Pump and Dump scheme? Definition

A Pump and Dump scheme is a type of stock market fraud that involves artificial inflation (“pumping”) of a stock price through false, misleading or exaggerated statements about the stock price. The fraudster can profit from inflates the price by quickly selling the securities at a high price (“dump”).

At the same time, the new owner of the stock is likely to lose a substantial portion of his or her capital, as the stock price will drop rapidly.

These schemes usually target penny stock or micro-capitalization stocks, as they are the easiest to manipulate and do not require many new buyers to drive a stock up.

However, it is an illegal practice under securities law and can result in heavy fines.

How does the Pump and Dump scheme work?

As we have already mentioned, the Pump and Dump scheme is a type of fraud with which the malicious fraudster attempts to boost the price of a stock through recommendations based on false and misleading claims.

But how exactly does a Pump and Dump scheme work?

Pump and Dump schemes were traditionally carried out by cold calling. But with the arrival of the Internet, this illegal practice has spread even further and can be carried out through email, spam and fake news.

Generally, scammers post messages online inviting investors to buy shares quickly, claiming to have inside information about an alleged increase in share price. Once buyers take the bait and get involved, the scammers sell their shares, causing the price to drop dramatically and new investors to lose money.

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Therefore, the announced price increase is based solely on exaggeration and demand, rather than solid business fundamentals.

Types of Pump and Dump schemes

There are several types of Pump and Dump schemes that can be used by scammers.

Pump and Dump ‘classic’ scheme

The classic scheme consists of the manipulation of information about a company and its actions. It can include telephone stock presentations, false press releases and the distribution of some type of “internal” information that can pumps up the price of the shares, thus attracting investors’ attention to the shares.

  1. Boiler room pump and dump scheme

A Boiler room means a small brokerage firm that uses a number of brokers who use dishonest sales practices to sell questionable investments to investors. If you’ve seen ‘The Wolf of Wall Street’, you know what I’m talking about.

The brokers sell penny stocks that the company buys or sells as a market maker through cold calls. Brokers working in the Boiler Room try to sell as many shares as possible, thus increasing their stock. Once the price goes up, the company sells its stock for a profit.

  1. Pump and Dump “Wrong Number” Scheme

The “wrong number” method is a new Pump and Dump scheme.

It is a practice that consists of sending voice messages to people with an investment suggestion to a friend. Then the person who receives the message believes that it came to him accidentally and could fall into the trap and invest in that stock following the ‘track’ received, thus increasing the demand for that title.

 

Example of how the crypto coin pump and dump works

In recent years there has been a massive adoption, by many fraudsters, of the Pump and Dump schemes in the world of cryptology.

In the case of crypto-currencies, the Pump and Dump scheme works in the same way as the classic one adopted in the bag, but it is backed by technology.

Behind this scam there is always one person or a small group of people with followers who normally boast a good reputation on the net. This person chooses the crypto currencies that have little volume and value (being these the easiest to manipulate and with a small injection of capital they can increase their price considerably.

The fraudster begins to buy that crypt-currency in a massive way, raising the price a little and passing the information (through channels such as Telegram, Facebook, etc.) to another small group of equally influential people in the network, who begin to buy massively, raising the price a little more.

Now the second group is spreading the word and also a third larger group starts buying based on the insider information obtained, but at a higher price. This last group in turn begins to give the news of the great wave of this crypto currency and little by little other traders begin to join in, seeing a great opportunity for profit.

At the moment when the leader or the leading group believes that they have earned enough and don’t want to take any more risks, they start to sell the crypt currency. Those in the second and third group will do the same and, in the meantime, the price begins to fall to the detriment of the last ones who entered.

This scam usually lasts a few hours or a few days and is characterized by increases that can cause the price of the crypto to rise between 100% and 500%.

This stratagem has fooled so many people that it has become very common and some analysts have calculated that, on average, there are at least two scams every day of this type that generate more than six million euros of transactions per month.

Some figures of Pump and Dump schemes made with crypto currencies

Some time ago, some analysts from the Social Science Research Network (SSRN) discovered that thousands of groups belonging to instant messaging platforms (Discord, telegram, messenger) participate in Pump & Dump schemes in the Crypto market.

To give just a few figures, the research revealed that for example 2 years ago (between January and June 2018) almost 5,000 attempts to promote this type of scheme were identified.

Through these channels, fraudsters have tried to promote at least 300 cryptos with a low trading volume.

In fact, the report has shown that “growing little-known tokens with a low volume of trade is much more profitable than trying to grow the currencies that dominate the market.

However, history has shown that major cryptos are not immune to Pump & Dump schemes.

For example, 76 groups that used these schemes to obtain bitcoins were discovered in Telegram, as well as another 6 in Discord.

According to SSRN, the growing popularity of this type of scam is due to the lack of regulation of the crypto currency industry.