DeFi pump-and-dump schemes cost millions and undermine industry integrity.
The cryptocurrency space has often been compared to the Wild West, and while it has matured to closely resemble the world of traditional finance, in the decentralized finance (DeFi) space, a “wild” discipline remains, often with freewheeling activity. They lead to pump-and-dump programs and the laundry business.
Pump and dump schemes often trick actors or actresses into buying tokens under false pretences, excitement and fear of loss to secretly dump their stakes at high prices.
According to some estimates, more than two million cryptocurrencies have been launched so far, most of which have been abandoned. On the Ethereum network alone, according to a recent Chinalysis study, more than 370,000 tokens will be launched by 2023, with 168,600 listed on decentralized exchanges (DEXs).
90,000 Ethereum tokens show market manipulation patterns
According to the study, in any given month, “less than 1.4% of tokens achieved more than $300 in DEX liquidity in the following month.” By 2023, only 5.7% of tokens in Ethereum have now entered above that level.
The company also found that “approximately 90,408 tokens” had less than $300 in liquidity on these exchanges, and one address that “removed more than 70% of its liquidity in five or more previous DEX purchases per transaction.”
Chinalysis notes that the method does not mean that these 90,408 tokens were a pump-and-dump scheme. Instead, it shows how authorities can use on-chain data to spot suspicious patterns.
Actors who launch tokens that meet the above criteria will earn approximately $241.6 million in profits by 2023, not including other costs to build and launch the profits.
Some have issued multiple tokens that meet the criteria, one wallet is estimated to have made $830,000 in profit by promoting 81 different tokens.
Jason Sonsato, head of public policy for North America at Chinalysis, told Cointelegraph that the release of a regulatory framework for cryptocurrency markets will help mitigate insider trading by “clarifying and defining the rules that trading platforms must follow to mitigate this risk with a market regulator with enforcement powers. Somensatto added:
“Unlike TradFi, whose security is primarily traded on a single exchange, crypto assets are traded across multiple platforms and decentralized financial protocols, meaning traditional reliance on monitoring data from a single trading venue is no longer sufficient.”
Regulators, he said, “need to become better educated on the evolving market structures in crypto and change the way they think about mitigating risks such as insider trading.”
Pavel Matveev, CEO of crypto payment service provider Wirex, told Cointelegraph that these patterns “usually happen when unethical group members who participate in a token exchange are the first buyers.”
Matveev added that this is “especially common for newly minted memecoins.” In stock markets, insider trading is “more difficult because there is more regulation” and unethical trading is investigated by both exchanges and regulators, and funds are easily recovered.
For Matveev, centralized and decentralized cryptocurrency exchanges “can at least increase their risk warnings and clearly show insider trading to traders. He added that in the short term, “pump and dump plans will support the exchange given the high transaction fees involved.”
“A Big Change in Industrial Integrity”
According to Wirex's CEO, a possible solution to the problem may be to implement “neutral and/or transparent third-party authentication.”
For Mark Taylor, global financial fraud reporting officer and head of financial crime at cryptocurrency exchange Cex.io, holding bad actors accountable can be difficult in the cryptocurrency space.
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Taylor told Cointelegraph that this is largely due to unclear or underdeveloped legal language that regulators rely on in their efforts to protect fairness and industry. But he added that these types of traders will have a negative impact on the credibility of the industry.
“It is critical for leaders to understand that every act of fraud or deception is detrimental to industry credibility. Participants who choose to hold and trade the value of the digital economy often do so to escape the banking sector, which they believe is an untrustworthy system.
He added that crypto is “susceptible to the same weaknesses as traditional finance” and risks alienating users who “appreciate the personal agency of blockchain networks.” He said this could happen until consumers once again find refuge in banks.
To “make a more compelling argument for mass adoption,” Taylor said, the cryptocurrency community must “commit to distinguishing itself by working to eradicate these practices.”
For Taylor, the adoption of regulations such as the EU Markets in Crypto-Assets Regulation is a step to promote constitutional integrity and laws that prevent fraud and abuse. These measures could see the industry see fewer instances of fraud, he said.
Influencer Pump Projects “Blooming Overnight”
Taylor said that while startups require an incubation period before selling shares, memecoin markets “can grow overnight,” with projects often responding to trends or jokes in grassroots communities.
Some “inside traders make tips by deploying highly focused positions,” while others place their buy orders ahead of major announcements, “which allows holdings purchased at pre-half price to quickly increase after the sale is announced.”
These plans are quickly becoming visible on chain tracking services such as Lookonchain, which saw a trader turn $90 Solana (SOL) tokens into $2 million five minutes after trading began in late 2023.
Starting from 1.5$SOL ($92), this trader made $2M in 22 days, a 21,715x profit!
This trader saw $SILLY 5 minutes after opening a trade and spent 1$SOL($62) to buy 43.1M $SILLY.
He then sold $33.34M SILLY for $528K and currently has $9.76M Silly ($1.5M) left… pic.twitter.com/ByY1Tpupah
— Lookonchain (@lookonchain) December 27, 2023
Taylor said that crypto influencers who encourage snap decisions bear some of the blame for financial losses: “Their position may represent a conflict of interest and result in financial losses.
Many influencer accounts accept payments in exchange for project promotions mentioned on their channels, which ends up promoting the project. He added that this could see regulators go after content creators as “the real masterminds squander their loot on the outer fringes of the ecosystem.”
Kathleen Barnett, director of regulation and compliance at Chainalysis, told Cointelegraph that celebrities and influencers “move global crypto markets with a single tweet or Instagram post.”
As a result, several celebrities have been indicted by the United States Securities and Exchange Commission (SEC) for illegally promoting cryptocurrencies and related investment schemes. In the year In October 2022, Kim Kardashian agreed to pay the SEC $1.26 million to settle such a case, while SEC Chairman Gary Gensler warned celebrities about crypto promotions in 2023.
Hiding pump and dump plans
Despite these enforcement measures, regulators have yet to crack down on cryptocurrency pump-and-dump schemes and insider trading, as evidenced by the Chainlysis study.
Cex.io's Taylor told Cointelegraph that “many of the safeguards in traditional finance can be applied to crypto with similar success to combat market manipulation and fraud.” Regulators are “hampered by a lack of legal precedent and confusing guidelines to detect and enforce misconduct in the crypto space,” he said.
Considering these issues, the authorities often work backwards from the victims due to the “excessive use of crypto social media” which can be “quickly disputed”.
Restoring the money also depends on arresting and prosecuting the perpetrators, Taylor said, adding that disrupting bad actors could be a strategy “to better protect retail participants and curb their ability to abuse power in the industry.”
For Wirex's Matveev, blockchain forensics can effectively track misappropriated funds, and the biggest challenge regulators face is successfully setting up a “robust and competent system that can be designed in a timely manner.”
As safe as it is, Taylor told Cointelegraph, he adds a healthy dose of skepticism to avoid clouding judgment. he said:
“Little-known symptoms that appear out of nowhere and show a quick profit should always be approached with health doubts. Such a method can be used to create noise, and above all, if there is no proper evaluation, it is urgent to take action.”
In addition, on-chain manipulation can help identify where network signals are being captured and reveal potential red flags. If a small number of wallets hold cryptocurrency offerings, Taylor said, “it might be prudent to consider another way forward.”
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These plans, at the end of the day, are destructive to the cryptocurrency market and should be actively discouraged. The Chinalysis study found that market operators and government agencies could deploy surveillance tools on blockchain to bring about the inherent transparency of traditional markets.
While much can be done to prevent these schemes, it can be beneficial to develop a mindset that encourages investors to do their own research and be careful with their money in the pursuit of wealth.
Sustaining the cryptocurrency space depends not only on the entry of major institutions such as BlackRock and Fidelity, and the launch of bitcoin exchange-traded funds, but also on the safety of investors exploring the edge of the cryptocurrency.
