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History shows that  – whenever possible – people find means to defraud and enrich themselves at the expense of other inexperienced people. New technology most often opens new means for con artists and fraudsters to enrich themselves at the expense of naive retail investors.

Research on pump and dump schemes done by the WSJ
Research on pump and dump schemes done by WSJ

Traders of cryptocurrencies often hear the term “Pump and Dump” and probably already have lost some money being trapped on the wrong end of a scheme of fraudulent insider trading. But those schemes are nothing new, they go back to the 19th Century. Schemes defrauding investors on stock markets actually triggered the crash on Wall Street in 1929 that led to a deep and lasting recession.  This was the first time in history where regular citizens of all classes engaged in buying stocks resulting in a crash with a disastrous impact.

New Circumstances Need New Rules

The massive securities fraud on the capital markets in the 1920´s required the enacting of the Securities Act back in 1933 becoming the first federal legislation used to regulate the stock market and fight market manipulation and fraudulent schemes. In 1934, the U.S. Securities and Exchange Commission (SEC) was established to enforce the new securities laws. The act created for the first time a uniform set of rules to protect investors against fraud with the SEC being its independent enforcement agency. It took those dramatic actions to establish the lost investors’ confidence in the very best interest of the capital markets and the economy.

During the DotCom bubble of the late 1990s book-running pump- and dump was a very popular scheme operated by unscrupulous investment banks.  The so-called “boiler room” brokerage ventures like the notorious Stratton Oakmont, founded by “Wolf of Wall StreetJordan BELFORT even made it to Hollywood with Leonardo DICAPRIO. In 1999, Mr. Belfort pleaded guilty to charges of securities fraud for running pump-and-dumps affecting 34 companies and costing investors more than $200 million in losses.

Evidently, with the new cryptographic technologies and blockchain concepts we experiencing the same level of greed and disgusting behavior in the crypto-market.

Telegram Channels are the New Boiler Rooms

The article Traders Are Talking Up Cryptocurrencies, Then Dumping Them, Costing Others Millions published by Shane Shifflett and Paul Vigna report the results of a great piece of research done by The Wall Street Journal by reviewing trading data and online communications among traders between January and the end of July 2018.

The journal ‘s research identified 175 “pump and dump” schemes involving 121 different crypto-coins, generating at least $825 million in trading volume over the past six months — and hundreds of millions in losses for those caught on the wrong side.

The article excellently points out how people in a “Jordan Belfort” approach use Telegram channels as a kind of digital boiler rooms to organize and manage pump and dump schemes for obscure and low-liquidity coins. First, they organize the pump to drive the prices up just to dump them accordingly at the expenses of the inexperienced slower-acting retail investors. New business models are created around those schemes: To join such a boiler room Telegram channel and to benefit of such obscure trading activities fees have to be paid. According to the journal, those “boiler room models” are quite successful.

A classical curve of a cryptocurrency in a pump and dump scheme
A classical curve of a cryptocurrency in a pump and dump scheme

Typically, collapsing bubbles have a strong negative impact on the capital markets. Exchanges crash along with the entire venture capital industry and the start-up scene. Valuations and market capitalizations just vaporize as well and finally the “real” economy is massively damaged for years. We have experienced that in the DotCom bubble and also in the real-estate (subprime mortgage) bubble in the late-2000s.

The Crypto-Hype Aftermath

After all those bubbles the defrauded investors lost trust and faith. We are unfortunately approaching the same situation in the crypto market. At the moment fraudulent ICO’s and crypto-investment schemes are more likely the rule and not the exception. The same seems to be true for the secondary market manipulation on crypto-exchanges. Once again we may be faced with two decisive consequences:

  • destroyed TRUST of retail investors and
  • governmental intervention and enforcement actions.

Human behavior doesn’t change!

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