The world of cryptocurrencies has often been compared to the Wild West, with its decentralized finance (DeFi) sector still embodying a “wild” mentality. This has led to rampant trading activities such as pump-and-dump schemes and wash trading. Pump-and-dump schemes involve manipulative actors who deceive 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 to date, most of which have been abandoned. In 2023 alone, over 370,000 tokens were launched on the Ethereum network, with 168,600 listed on decentralized exchanges (DEXs). However, only a small percentage of these tokens achieve significant liquidity, with just 5.7% of tokens launched in 2023 on Ethereum surpassing $300 of DEX liquidity.
The study also identified approximately 90,408 tokens that had less than $300 in liquidity on DEXs. It found that a single address removed over 70% of liquidity in a single transaction, raising suspicions of market manipulation. However, Chainalysis clarifies that these patterns do not necessarily indicate pump-and-dump schemes but rather demonstrate how on-chain data can help authorities identify suspicious activities.
Actors who launched tokens meeting the study’s criteria reportedly made around $241.6 million in profit in 2023, excluding the costs of building and launching the tokens. Some individuals launched multiple tokens meeting the criteria, with one wallet launching 81 different tokens and making an estimated profit of $830,000.
Jason Somensatto, head of North America public policy at Chainalysis, believes that establishing a regulatory framework for cryptocurrency markets can help mitigate insider trading by clarifying the rules that trading platforms need to follow and identifying a market regulator with enforcement authority. He emphasizes the importance of educating regulators about the evolving market structures in crypto 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, he acknowledges that in the short-term, pump-and-dump schemes benefit exchanges due to the substantial fees involved.
To combat these issues, Matveev proposes implementing an independent and transparent third-party detector. Mark Taylor, global money laundering reporting officer and head of financial crime at Cex.io, an exchange, believes that the cryptocurrency community must commit to eradicating these practices to make a more convincing argument for mass adoption. He sees the approval of regulations like the European Union’s Markets in Crypto-Assets Regulation as a promising step towards promoting ecosystem integrity.
Taylor also highlights the role of influencers in pump-and-dump schemes, as they often encourage impulsive decision-making and may have conflicts of interest. He suggests that regulators should focus on content creators and their promotions, rather than pursuing them while the real masterminds behind fraudulent schemes escape scrutiny.
Authorities face challenges in combating pump-and-dump schemes and insider trading due to the lack of legal precedent and clear guidelines in the crypto space. Taylor recommends applying the protections against market abuse and manipulation from traditional finance to the crypto industry. Additionally, he advises investors to exercise healthy skepticism and conduct their own research to stay safe.
Preventing these schemes requires a combination of monitoring tools, blockchain forensics, and investor education. By cultivating a discerning mindset that prioritizes research and caution over chasing quick riches, the cryptocurrency space can continue to grow while ensuring the security of its investors.