The cryptocurrency space has been compared to the Wild West numerous times, and while it has been maturing to resemble the world of traditional finance more closely, in the decentralized finance (DeFi) space, the “wild” ethos remains, with freewheeling trading activity often leading to pump-and-dump schemes and wash trading.
Pump-and-dump schemes usually consist of an actor or group of actors manipulating investors with false claims, excitement and fear of missing out to make them buy tokens while they covertly dump their own stakes at higher prices.
According to some estimates, over two million cryptocurrencies have been launched so far, most of which have been abandoned. On the Ethereum network alone, according to a recent Chainalysis study, over 370,000 tokens were launched in 2023, with 168,600 listed on decentralized exchanges (DEXs).
90,000 Ethereum tokens display market manipulation patterns
According to the study, in any given month, “fewer than 1.4% of all tokens launched achieve more than $300 of DEX liquidity within the subsequent month,” with just 5.7% of tokens launched in 2023 on Ethereum now above that threshold.
Further, the firm found that “approximately 90,408 tokens” had less than $300 in liquidity on these exchanges and a single address that “removed more than 70% of liquidity in a single transaction with five or more previous DEX purchases.”
Chainalysis notes that its methodology doesn’t necessarily mean these 90,408 tokens were the subjects of pump-and-dump schemes. Instead, it shows how authorities can use on-chain data to spot suspicious patterns.
Actors who launched tokens meeting the above criteria “collectively made approximately $241.6 million in profit in 2023, not accounting for other costs to build and launch the profit.”
Some launched multiple tokens meeting the criteria, with one identified wallet launching 81 different tokens, making them an estimated $830,000 profit.
Speaking to Cointelegraph, Jason Somensatto, head of North America public policy at Chainalysis, said that the adoption of a regulatory framework for cryptocurrency markets could help mitigate insider trading “by clarifying the rules that trading platforms need to follow to address this risk and by identifying a market regulator with authority for enforcement.” Somensatto added:
“Unlike in TradFi where a security primarily trades on a single exchange, crypto assets trade across numerous platforms and decentralized financial protocols, which means that traditional reliance on looking at data from one trading venue is not sufficient.”
Regulators, he said, “need to be better educated on the evolving market structures in crypto and change the perspective by which they think about mitigating risks like insider trading.”
Pavel Matveev, CEO of crypto payments service provider Wirex, told Cointelegraph that these patterns “typically occur when unethical team members involved in the scheduled deployment of a token are also its initial buyers.”
Matveev added that this is “particularly common for newly issued memecoins.” In equities markets, he added, insider trading is “more difficult because there is much more oversight,” and unethical trading is scrutinized by both exchanges and regulators, while funds are more easily recovered.
To Matveev, centralized and decentralized cryptocurrency exchanges could “at the very least, enhance their risk warnings and explicitly disclose the likelihood of insider trading to traders.” He added, however, that in the short-term, “pump-and-dump schemes favor exchanges, given the substantial exchange fees involved.”
A “blow to industry credibility”
A potential solution to the problem, according to Wirex’s CEO, could be implementing an “independent and/or transparent third-party detector.”
To Mark Taylor, global money laundering 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 vague or underdeveloped legal language that regulators rely on in their pursuit of justice and industry protections.” Nevertheless, he added that these types of traders affect the credibility of the industry negatively.
“It’s crucial for leaders to understand that every instance of fraud or collusion is a blow to industry credibility. Participants who choose the digital economy to hold and transact value are often doing so to avoid the banking sector, which they view as an untrustworthy system.”
He added that when crypto “proves itself susceptible to the same shortcomings as traditional finance,” it risks alienating users “who appreciate the personal agency of blockchain networks.” This, he said, can happen to the point where users turn to seek refuge in banks again.
Taylor noted that to make a “more convincing argument for mass adoption,” the cryptocurrency community must “commit to setting itself apart by working to eradicate these practices.”
To Taylor, approving regulations like the European Union’s Markets in Crypto-Assets Regulation is a promising step to promote ecosystem integrity by establishing rules and sanctions against manipulation and abuse. These measures, he said, could see the industry experience fewer instances of fraud.
Influencer pump projects that “bloom overnight”
Taylor said that while startups require an incubation period before selling shares, memecoin markets “can bloom overnight,” with projects often cropping up in response to trends or jokes within niche communities.
He said that some “insider traders act on tips by deploying precision-focused positions” while others place their buy orders ahead of major announcements, “which allows their holdings purchased at a pre-hype valuation to increase rapidly once the sale goes public.”
These schemes are often quickly spotted by on-chain monitoring services like Lookonchain, which found a trader who turned $90 worth of Solana’s (SOL) token into $2 million after buying a cryptocurrency just five minutes after it started trading in late 2023.
Starting with only 1.5 $SOL($92), this trader made $2M in 22 days, a gain of 21,715x!
— Lookonchain (@lookonchain) December 27, 2023
This trader spotted $SILLY 5 minutes after it opened trading and spent 1 $SOL($62) to buy 43.1M $SILLY.
Then he sold 33.34M $SILLY for $528K, and currently has 9.76M $SILLY($1.5M) left,… pic.twitter.com/ByY1Tpupah
Taylor said that crypto influencers who encourage impulsive decision-making carry some of the blame for potential financial harm: “their insistence could suggest a conflict of interest and lead to financial harm.”
Many influencer accounts, he said, accept payments in exchange for project promotions on mentions on their channels, which ends up manufacturing hype for the project. He added that this can see regulators chase down content creators “while the real masterminds launder their pilfered wealth on the ecosystem’s outer rim.”
Speaking to Cointelegraph, Caitlin Barnett, director of regulations and compliance at Chainalysis, said that there have been cases in which celebrities and influencers “move global crypto markets with a single tweet or Instagram post.”
A number of celebrities have, as a result, been charged by the United States Securities and Exchange Commission (SEC) for illegally promoting cryptocurrencies and associated investment schemes. In October 2022, Kim Kardashian agreed to pay the SEC $1.26 million to settle such a case, while SEC Chair Gary Gensler warned celebrities against crypto promotions in 2023.
Dodging pump-and-dump schemes
Despite these enforcement actions, regulators have so far been unable to rein in cryptocurrency pump-and-dump schemes and insider trading, as evidenced by Chainlaysis’ study.
Cex.io’s Taylor told Cointelegraph that “many of the protections that exist in traditional finance to combat market abuse and manipulation could be applied to crypto with similar success.” Regulators, he said, are “stymied by a lack of legal precedent and hazy guidelines to define and enforce wrongdoing in the crypto space.”
Considering these issues, authorities often work backward from the victims in a process “which can quickly become muddied” given the “oversaturation of crypto social media.”
Restoring funds is also contingent on perpetrators being apprehended and prosecuted, Taylor said, before adding that disincentivizing bad actors to “kneecap their ability to misuse levers of power within the industry to better protect retail participants” could be a strategy.
To Wirex’s Matveev, blockchain forensics can efficiently track misappropriated funds, and the biggest challenge regulators face is successfully setting up a “strong and qualified workforce capable of designing an efficient procedure on time.”
Staying safe, Taylor told Cointelegraph, involves a dose of healthy skepticism to avoid clouded judgment. He said:
“Lesser known tokens that appear out of nowhere and demonstrate immediate gains should always be approached with healthy skepticism. Such a tactic could be used to generate hype, and more importantly, an urgency to act without proper assessment.”
On top of that, on-chain sleuthing can help determine where a network’s tokens are being held and reveal potential red flags. Taylor said it “may be prudent to consider another path forward” if a small number of wallets hold the bulk of a cryptocurrency’s supply.
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These schemes, at the end of the day, are destructive for the cryptocurrency market and should be actively discouraged. The Chainalysis study notes that market operators and government agencies can deploy monitoring tools on the blockchain in a way that wouldn’t be possible in traditional markets, given their inherent transparency.
While a lot can be done to help prevent these schemes, cultivating a discerning mindset that promotes investors doing their own research and being cautious with their funds over chasing riches could also prove beneficial.
Furthering the cryptocurrency space rests not only on the entrance of major institutions like BlackRock and Fidelity and their launch of spot Bitcoin exchange-traded funds, but also on the security of investors exploring the cutting edge of DeFi.
