The cryptocurrency industry has often been compared to the Wild West, and while it has matured in many ways, the decentralized finance (DeFi) space still embodies the “wild” ethos. Freewheeling trading activity frequently leads to pump-and-dump schemes and wash trading.
Pump-and-dump schemes involve manipulating investors with false claims, excitement, and fear of missing out, causing them to buy tokens while the manipulators secretly sell their own stakes at higher prices.
According to a recent study by Chainalysis, over two million cryptocurrencies have been launched so far, with most of them being abandoned. On the Ethereum network alone, 370,000 tokens were launched in 2023, with 168,600 listed on decentralized exchanges (DEXs).
The study found that less than 1.4% of all tokens launched in a given month achieve more than $300 of DEX liquidity in the subsequent month. Only 5.7% of tokens launched in 2023 on Ethereum are currently above that threshold.
Furthermore, approximately 90,408 tokens had less than $300 in liquidity on DEXs, and a single address removed more than 70% of liquidity in a single transaction, following five or more previous DEX purchases.
Chainalysis clarifies that this methodology does not necessarily mean that these 90,408 tokens were involved in pump-and-dump schemes. Instead, it demonstrates how on-chain data can be used to identify suspicious patterns.
The actors who launched tokens meeting the above criteria collectively made approximately $241.6 million in profit in 2023, not accounting for other costs.
Some of these actors launched multiple tokens meeting the criteria, with one wallet identified as launching 81 different tokens and making an estimated $830,000 profit.
Jason Somensatto, head of North America public policy at Chainalysis, believes that adopting a regulatory framework for cryptocurrency markets could help mitigate insider trading. He suggests that regulators need a better understanding of the evolving market structures in crypto and a change in perspective to effectively address risks like insider trading.
Pavel Matveev, CEO of Wirex, a crypto payments service provider, suggests that centralized and decentralized exchanges should enhance their risk warnings and explicitly disclose the likelihood of insider trading to traders. However, Matveev acknowledges that pump-and-dump schemes currently favor exchanges due to the substantial fees involved.
To combat these issues, Mark Taylor, global money laundering reporting officer at Cex.io, believes that applying the protections against market abuse and manipulation from traditional finance to the crypto space could be effective. However, regulators face challenges due to a lack of legal precedent and clear guidelines for defining and enforcing wrongdoing in the crypto industry.
Influencers in the crypto space also play a role in pump-and-dump schemes by encouraging impulsive decision-making. Caitlin Barnett, director of regulations and compliance at Chainalysis, notes that celebrities and influencers can move global crypto markets with a single tweet or Instagram post.
Regulators have struggled to rein in pump-and-dump schemes and insider trading in the crypto space. Authorities often work backward from the victims, but the oversaturation of crypto social media makes the process challenging. Restoring funds is contingent on apprehending and prosecuting the perpetrators.
Blockchain forensics can track misappropriated funds, but regulators need a qualified workforce to design an efficient procedure. Staying safe involves skepticism and conducting thorough research. On-chain sleuthing can also help identify potential red flags.
Preventing these schemes requires a combination of monitoring tools, investor education, and a discerning mindset that prioritizes cautious investment practices. The growth of the cryptocurrency space depends not only on the participation of major institutions but also on the security of investors in the DeFi sector.