Pump and dump: New era of cryptocurrency scam
– Shiv Sankar
Introduction
Pump and Dump refers to a financial scam in which false and misleading claims are used artificially to promote and inflate a stock. Because the price in most instances of planned Pump and Dump declines, buyers who purchased at the top of the market lose the value of their assets. These methods artificially increase the price of an asset so that a select few can sell at a higher price. For cryptocurrencies, a signal indicating which currency to buy is sent to insiders via a group messaging platform at the start of a pump. From the pumpers’ perspective, coordinated buying should increase trade activity and begin to drive up the price. When other buyers become interested and start buying, the price rises even further, the pumpers then sell the positions they bought earlier at entry prices. In the equity market large scale scams have occurred using pump and dump such as Harshad Mehta and Jordan Belfort who are big investors or brokerage companies, seeking penny stocks because they have low values which can be easily inflated. Pump and Dump also takes advantage of the psychological fear of missing out. As a result, the hunt for comparable equities causes ordinary investors to fall prey to such scams.
Operation of Scam in Cryptocurrencies: Pump and Dump
Since cryptocurrency is not classified in India, the SEBI regulations won’t be valid and the Regulation 8(2) of the Issue and Listing of Debt Securities Regulations, which prohibits the issuer from “issuing an advertisement which is misleading, or contains any distorted information so as to appear manipulative or deceptive” hence the misleading information about the currency can’t be penalized. Numerous activity reports indicate that these Pump and Dump organisations almost exclusively target less recognised currencies, particularly ones with a low market value and limited circulation because they are considered easier to manipulate. It is impossible to estimate the entire extent of the damages caused by Pump and Dump schemes; nonetheless, there is evidence that such schemes generate millions of dollars in trading activity. The Wall Street Journal performed a six-month study on the fraud, which revealed 825 million dollars in the total scam and one organisation were responsible for 222 million dollars in transactions alone.
India’s Stance
The cryptocurrency sector in India is a grey area; the main difficulty with this realm is that it is unregulated, with the big issue of Pump and Dump; many investors may fall into these scams in the hopes of enormous profits. The increased drive for compliance comes at a time when interest in cryptocurrency investing is on the rise in India. There is currently no legislation or prohibition in place in the country regarding the usage of cryptocurrencies. The Supreme Court of India overturned the Reserve Bank of India’s (RBI) ruling prohibiting banks from enabling crypto transactions in March 2020. According to the draft bill, the Securities Exchange Board of India (SEBI) will be the cryptocurrency regulator.
According to statistics provided to Mint by the cryptocurrency exchange, 70 percent of its customers were under the age of 34, and 85 percent were men. Following a strong increase over the last month, the market capitalisation of cryptocurrencies has surpassed $1 trillion. On December 16, 2020, Bitcoin exceeded its 2017 top of just under $20,000, and it now trades at $40,000. WazirX, India’s largest cryptocurrency exchange, now has over a million members, up from the 550,000 it announced in a blog post in June 2020. In 2020, the exchange recorded $2.34 billion in trades.
Outlook on the US Jurisdiction
Stock market Pump and Dumps frequently entails some misleading information or activity, but cryptocurrency Pump and Dumps does not. Because bitcoin Pump and Dumps are marketed on social media, it is also simpler to recognize them. The creator of antivirus firm MacAfee was identified a recent Pump and Dump fraud Commodity Futures Trading Commission, Vs John David Mcafee and Jimmy Gale Watson, Jr., involving trading currencies like as Dogecoin and Reddcoin, which were pushed on Twitter. John MacAfee profited an estimated $2 million from these fraudulent trades. Elon Musk experienced a windfall as a consequence of Bitcoin’s unexpected rise. In the first quarter of 2021, Elon Musk bought $1.5 billion in Bitcoin, helping to push the price up to about $65,000 in mid-April. Musk subsequently sold 10% of the company’s stock around the top in Q1, pocketing a pretax profit of $101 million. Musk owned 42,100 Bitcoin at the end of March, according to Fortune. According to its most recent 10-Q, it holds the coins for $1.33 billion, or “carrying value.” This implies that the coins on its books cost an average of $31,600. Musk’s actions would have violated Section 4(2) of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices in the Securities Market) Regulations, 2003, which states that “No person shall engage in a manipulative, fraudulent, or unfair trade practice in the securities market,” but he would not be held liable because cryptocurrencies have yet to be classified in India and there is no regulator.
Bittrex, a cryptocurrency exchange located in the United States, announced the prohibition of Pump and Dumps on November 24, 2017. Although it was unable to eradicate Pump and Dumps completely, it was able to decrease the frequency of Pump and Dumps on its exchange. This restriction only applied to tokens traded on Bittrex, not tokens traded on other exchanges. While there are numerous elements of cryptocurrency legislation to consider, results indicate that Pump and Dumps should be regulated.
To counteract the catastrophic problem of Pump and Dump schemes in cryptocurrency markets, the United States Commodity Futures Trading Commission has offered cash incentives for whistleblowers participating in such Pump and Dump organisations. The Commodity Futures Trading Commission (CFTC) issued a consumer advisory statement alerting investors about bitcoin Pump and Dump scams. The CFTC warns users to avoid Pump and Dump schemes that can occur in thinly traded or new alternative virtual currencies, digital coins, or tokens, according to the statement. Customers should not buy virtual currencies, digital coins, or tokens based on social media recommendations or unexpected price increases.
In addition to the warning, the CFTC warned consumers that they could be considered for a monetary reward ranging from 10 percent to 30 percent of members of Pump and Dump groups can provide original data that leads to a monetary award of $1 million or more. In other words, the CFTC intends to compensate whistleblowers who provide important information that leads to the arrest of the perpetrators of such schemes. The concept of compensating whistleblowers is not new and is already widespread in conventional financial markets.
How India could shift the approach to these scams: Critical Analysis
Instead of overtly prohibiting cryptocurrency trade, fighting criminal activity, maintaining market integrity, and safeguarding the financial system’s safety and soundness, parts of the crypto-asset ecosystem must be regulated. Before implementing any new rules, it is necessary to clean up the current ecosystem in which the cryptocurrencies are traded. SEBI has previously engaged in several whistleblower initiatives, and this will be the appropriate measure to combat these fraudulent coins. Taking a similar approach as the CFTC, which gave a massive incentive for these malpractices, will undoubtedly entice involvement. Identifying these organisations is effortless; with strong motivation, SEBI can eradicate these scam coins and clean up the environment, making it a safe place for new investors.
Because of the nature of the majority of these currencies, new coins and initial coin offerings (ICOs) tailored for fraudulent activity. 80% of ICO’s are fraudulent in nature; thus, regulatory bodies should list coins that are sufficiently stable and supported by credible sources should only be listed for trade on exchanges.
Bringing cryptocurrency wallets and exchanges into the regulatory framework is one such way. Regulated cryptocurrency exchanges, which are already subject to money laundering rules, may be forced to include volatility control systems that prohibit large price variations from the last transacted price during a cooling-off period. Allowing secure and consistent cryptocurrencies will aid in the eradication of these scams and the creation of a far more stable market.
Regulations occur in every area, whether it is banking, capital markets, or insurance; despite the efforts of these authorities, scammers continue to occur, but we can still restrict these scams. We can reduce P&D schemes in India with the help of a watchdog-like organisation by identifying criminals & penalising them and promoting awareness. Setting up a voluntary trade body for the cryptocurrency market, such as The Association of Mutual Funds India (AMFI), will aid in maintaining high professional and ethical standards, as well as conducting a national investor awareness campaign to encourage adequate knowledge of the concept and operation of cryptocurrency. This technique will not only promote awareness but will also help to create a healthier market.
Cryptocurrency is unregulated; scams like Pump and Dump are expected to grow in popularity. The enormous profits made by the scams will only encourage scammers to search for new ways to conceal themselves from unwary traders. Regulatory inaction is inadequate in the face of apparent manipulation of cryptocurrency markets, such as pump and dump schemes. The uncertainty surrounding the future of cryptocurrencies, The RBI and SEBI do not have a regulatory framework in place to regulate cryptocurrencies directly. The present legislation is insufficient to address these concerns; this is significant because it appears that digital currency is here to stay. Institutions ranging from JP Morgan, PayPal, BNY Mellon, America’s oldest bank, are all getting in on the action. Governments worldwide have been competing to enact crypto-friendly legislation to create jobs, attract talent, and brand themselves as leaders in crypto innovation, based on the idea that digital currency is the future of finance.
Shiv Sankar is a law student at National Law University, Odisha.