Introduction
Just like any other financial market, DeFi is also susceptible to scams and fraud. Rather than turning away from the benefits of crypto trading out of fear of these frauds, it is best to learn about them.
This article is going to inform the users about several types of financial frauds and focus on the particulars related to Pump and Dump Schemes. Cryptocurrency investors with awareness of these frauds can make better trading decisions and take preventive measures to avoid them.
What is a Financial Scam?
A financial scam is any incident when threat actors try to victimize unsuspecting cryptocurrency investors to defraud them. Financial scams are illegal, and they can cause harm to the participants. Scammers can take advantage of financial loopholes, or they may directly steal from their targets using hacking techniques.
Financial scams in DeFi are said to have become common because this technology is relatively new, and not every cryptocurrency investor is equipped to deal with these scams. Financial scams can be reduced by spreading the word about such threats and reporting these incidents to the proper authorities.
Types of Financial Scams
Here are the most common types of financial scams that investors working with DeFi can face:
Rug Pulls
Rug pulls take place when a cryptocurrency project issuer abandons their network without warning. These threat actors may try to gain popularity among investors by advertising their products extensively and gaining considerable followership.
The main goal of rug pulls to ensure that there are enough investors to give them a chance to increase the price of their cryptocurrency product and suddenly sell out and disappear. Some projects may offer custodial services and vanish with the funds of their users without warning them.
Under such circumstances, the users end up losing their cryptocurrency reserves, and they are unable to trace the defaulters. Sometimes, rug pulls scammers can find exploits in the smart contracts and create a backdoor for easy and unsuspecting escape.
Phishing Messages
Phishing messages are a scamming technique that is used by scammers using hacking techniques. These scammers can gain access to sensitive data and information about the users through malicious ware.
Scammers may send the targeted person or organization an email or message that is spiked with a link. If the victim clicks the said link, they can end up losing the contents of their digital wallets, and they may end up giving up the information available on their device, such as passwords, financial account credentials, and others.
Social Media Bluffs
Social media is a great source of information and a platform to interact with people from around the world. However, scammers may use this platform to defraud users who are not familiar with their tactics. They may post malicious links online or create a campaign to artificially pump the prices of a shit coin to dump it later.
Some scammers may impersonate celebrities and ask cryptocurrency investors to send those cryptocurrencies to a digital wallet with a promise to double it later. There are many types of social media scams online, and investors can learn about them by subscribing to the news.
Wallet Dusting
Wallet dusting is another scamming process that is used by hackers. The hackers send unsuspecting digital wallet users a small fraction of cryptocurrencies as gifts. When the users spend these cryptocurrencies, their sensitive information is leaked because these small crypt gifts or dust act like trackers.
They can steal the entire financial history of the users and send it to the attacker. This attack is not used to directly steal from the investors but to collect secret information about them like financial history etc.
However, this information can be used to blackmail the users or launch another cyber-attack on the target. This tactic can be used by government and intelligence agencies as well.
Airdrop Frauds
Airdrops are free cryptocurrency giveaways that ICOs or DeFi startups may grant to incentivize their first investors. Airdrops are not always a scam; in some cases, they can be legitimate. The idea is that the investors have a chance to purchase a cryptocurrency before it has made a public debut.
Investors who have faith in its later development can purchase these currencies for a small price. However, in fake Airdrops, investors are prompted to put their money into projects that have no plan of taking off in the future. Once the scammers have collected the money from their victims, they run away.
Airdrop scammers may convince the users to connect their wallets to the hacking addresses with the promise of a free crypto giveaway. As soon as their victims connect the wallet, they extract Trojan horses and can end up losing their crypto reserves.
Hack Attacks
In many cases, investors can lose their cryptocurrency reserves if their private keys are stolen using any type of hacking technique. Threat actors can send malware to the device of the investors to steal their personal information.
There are also some cases where the investors may get locked out of their devices or digital wallets on account of a Ransomware attack. Unless the target pays the hackers, they will remain locked out of their files and other important data.
What are Pump and Dump Schemes?
Some of the most common scams in DeFi have been mentioned above. However, there is another very dangerous defrauding method in DeFi that has been gaining popularity. This type of scam is called Pump and Dump scheme. This can be done without the cryptocurrency investors realizing what is going on.
The threat actors may start by purchasing a massive amount of a relatively unknown coin or shit currency. Once they have accumulated enough shit coins, they can start campaigning for the said currency by talking about its trading potential or other aspects that may not make a lot of sense.
However, if enough people buy the idea they can start accumulating this shit coin in hopes of making profits. During this time, the scammers can keep inflating the prices of the shit currency as much as possible.
Once the shit coin has been inflated to the largest possible level, the scammers dissolve their position suddenly, dumping a massive amount of the shit coin and driving the price down suddenly. Pump and Dump schemes are legal until the point that dumping happens. It is very difficult to differentiate between a viable crypto promotion and scammers.
How do Pump and Dump Schemes Work?
Pump and Dump Schemes may work, taking advantage of the lack of knowledge among cryptocurrency investors. Since DeFi is not regulated, scammers can get away with their schemes as they are operating outside of any legal restrictions or requirements.
Cryptocurrency investors who are unable to perform fundamental or technical analysis may take the sudden popularity of a cryptocurrency as a positive sign of its reliability.
When the investors fail to do any research on the cryptocurrencies they are purchasing, they create a possibility for them to get scammed. Cryptocurrency projects that offer no real value or do not have a sound technical background cannot retain their value in the long run.
Therefore, investors should research finding authentic cryptocurrency projects before investing in them. Many professional and trained cryptocurrency investors may partake in such schemes, but they can get out before the dumping happens as they understand the market dynamics.
Origin of Pump and Dump Schemes
Pump and Dump Schemes are part of the DeFi ecosystem today using online platforms. However, this scam has its roots in the stock market and started during the 1990s. The stock brokerage named Stratton Oakmont defrauded the investors by artificially inflating the prices of stocks under their ownership.
They achieved this feat by spreading false and misleading information in the market about the pumped stocks and talking about positive information regarding the company. They were able to make profits by dumping cheaply purchased stock at artificially inflated prices.
However, they were later convicted with charges of market manipulation, and the co-founder of the firm Jordan Belfort ended up serving time in jail on account of this conviction.
How do Pump and Dump Schemes Work in DeFi?
Pump and Dump schemes still happen in the cryptocurrency market as well as the stock market. However, regulators have increased their grip on the stock trading community to make sure that scammers end up getting caught. Financial regulators cannot control social media sites where scammers take advantage of unsuspecting users.
Several scamming channels are operating on Discord, where servers like Voyager Pump and Galactic Pump promote valueless cryptocurrencies to dump them later. They tell their users that they have found a possible pump signal for a given cryptocurrency using bots or special algorithms for technical analysis.
These channels can also host VIP access areas where the premium members get information about these pumps and dump them 5-10 minutes in advance. As visible to the investors, there are no special bots or algorithms; the scammers are just trying to pump a shit currency to earn profits later.
Scammers may use FOMO or Fear of missing out to defraud as many cryptocurrency investors as possible. Other social media sites, such as Reddit and Twitter, can also be exploited by scammers using the same methods. The reason that scammers can affect the cryptocurrency community is that they can create accounts on social media using fake names and be impossible to trace.
People will follow anyone on social media if they have enough followership. The scammers can gain followership using bots and other hacking techniques. Sometimes, influencers can be recruited by scammers to advertise a cryptocurrency without knowing anything about it or doing proper research.
Meanwhile, some morally questionable professional figures may perpetuate pump-and-dump schemes to make profits. The late founder of the Anti-virus brand McAfee was found to be propagating pump-and-dump schemes using his social media following. He is reported to have made $13 million in profits by promoting useless cryptocurrencies such as ETN.
How to Prevent Pump and Dump Schemes?
When it comes to Pump and Dump schemes, they can be very intricate and complex. Even regulators can have a difficult time trying to decipher them. Nevertheless, some methods can be used to prevent such scams by learning how to spot them as:
Price Movements
Price changes taking place during the pump and dump scheme are dramatic and often sharp. If a cryptocurrency is showing sudden unexplainable gains without any real reason, it may be subjected to a pump and dump scheme.
There are many blockchains and DeFi projects that undergo a price surge on account of a new update or due to any new business affiliation.
However, if the prices of a cryptocurrency have started to rise without any technical or business-related development, it is inorganic and suspicious. When the investors examine the price movement of that questionable currency, they may be able to spot a massive spike regardless of any connection to their technical or financial mechanism.
Investors can also beware of such pump-and-dump events by subscribing to online trackers that can alert them investors about them. A good example of such trackers is Walletinvest.com.
Source of Promotion
Investors must always try to find the source of a current cryptocurrency promotion. If there are influencers who are promoting cryptocurrencies that fall outside their market niche, the investors can rest assured that there may be some issues.
Rather than taking the word of anyone online with considerable followership, the investors should rely on research on a personal level. There are trading tools and online resources available at the disposal of cryptocurrency investors that can easily tell them the difference between a legit and a scam promotion.
There are several cryptocurrency market analysts on YouTube and other video streaming services that can invite their users to join Discord or other handles. Once they have enough followers, the scammers can start sending pump-and-dump signals.
They have already purchased shit coins in massive amounts, and they bet on earning profits by scamming their followers using shorting or long positions. Other social media websites, such as Facebook, are notorious for posting fake news online and inflating the prices of shit coins for dumping.
There are many cases where good-natured and sincere influencers end up promoting shit coins as part of paid promotions. It is not ideal to follow the advice of a stranger on account of their online followership. The investors are never sure if the influencer has performed research on the cryptocurrencies they are promoting or not.
When it comes to spending a substantial amount of money on investing anywhere, it is foolish to do so without ensuring the security and safety of these projects first using online trackers and basic market analysis.
Trading Volume Fluctuations
Much like the price movement, any unnatural trading volume spikes are the biggest indicator of an ongoing pump-and-dump scheme. Cryptocurrency investors would do better to stay away from such promotions even if they are thinking about making a profit. There is no way to predict when scammers will dump their cryptocurrency assets.
Even if the investors realize the correct time to sell and purchase their pumped currencies, they may not have enough time to complete the trade. They also run the risk of running out of liquidity due to unnatural changes in trading volume.
Market Capital
Market Capital is the total value of a DeFi project on account of its total supply and per unit spot price. When a cryptocurrency is used for pumping and dumping, it can undergo a sudden change from a nominal market cap to an exponentially inflated amount.
Market cap analysis for small capped currencies is a very good indicator of any suspicious activities happening in the background. When investors detect such events, they should try to warn others or avoid investing in such a currency that can drop to zero at any moment.
Regulatory Clarity
When cryptocurrency exchanges are regulated, they can prevent pumps and dumps using user verification methods such as personal information, KYC, and AML checks. The scammers cannot afford to propagate pump-and-dump schemes using their real identities because they can get intercepted by law enforcement agencies.
It is still possible to scam people using fake identities, but it becomes very difficult to do so and the cost of conducting the scam increases. At the same time, DeFi is a technology that has developed decentralized financial networks; devs can come up with preventive measures to curb such events without having to depend on regulatory structures.
Conclusion
Pump and Dump schemes have become less common in DeFi on account of spreading awareness among the masses. Every cryptocurrency investor has a responsibility to not only learn about recognizing these incidents but also report them to others.
At the same time, the DeFi developers can program preventive mechanisms in their projects that alert the users about possible scams and ensure their safety.