A New Wolf in Town? Pump-and-Dump Manipulation in Cryptocurrency Markets
Anirudh Dhawan, Talis J Putnins
Review of Finance, Volume 27, Issue 3, May 2023, Pages 935–975, https://doi.org/10.1093/rof/rfac051
Cryptocurrency markets witness a unique form of pump-and-dump manipulation. Manipulators use social media platforms such as Telegram to run open chat groups in which they publicly declare that they are pumping a given cryptocurrency (or “coin”) and urge others to join. Manipulators inform followers ahead of time about their intentions to conduct a pump at a given time and on a given cryptocurrency exchange. However, they only disclose the name of the coin at the time of the pump, through a “pump signal.”
We examine 355 such cases of pump-and-dump manipulation within a period of six months on two exchanges (Binance and Yobit) and find these schemes are very effective and popular. The manipulated coins witness sharp price increases (65% on average) immediately after the pump signal and sharp reversals, on average, around eight minutes after the pump signals. In aggregate, these pumps are associated with roughly $350 million of trading on manipulation days, affect 197 different coins, and earn the manipulators around $6 million.
We investigate the puzzle of participation in these manipulation schemes. These manipulations cannot be explained by the traditional mechanisms such as information asymmetry and asymmetry in price impact. We develop a theoretical framework to demonstrate that rational individuals lacking a speed or skill advantage would not participate in pump-and-dump manipulations because, for participants other than the manipulators, these pumps provide negative expected returns.
We use the framework to illustrate two types of individuals who willingly participate in pumps. The first is overconfident individuals, who overestimate their ability to sell at a price close to the peak. The second type is individuals who use pumps as a form of gambling, attracted by the possibility of large gains and the right-skewed payoff distribution that pumps can generate under certain conditions. We find strong empirical evidence to suggest that participation in pumps (as proxied by volumes generated by pumps) can be explained by both overconfidence (as proxied by past success in pumps) and gambling (as proxied by the aggregate level of cryptocurrency gambling).
The behavioral channels of overconfidence and gambling preferences do not just explain participation in these manipulation schemes but can also apply, more generally, to speculative bubble games in markets. If we strip out the manipulation angle, at their core, cryptocurrency pump-and-dumps are a type of bubble game. In such games, agents disregard a security’s fundamentals and purchase it in the belief that they can sell it to others that will want to buy it in the future at higher prices. Such games have gained popularity in markets recently. One prominent example of such a game is the “meme stocks” phenomenon, whereby traders in social media forums co-ordinate their speculative purchasing of relatively illiquid companies to generate large price increases usually followed by a collapse of the price. Our paper provides some intuition as to why such bubble games attract market participants in large numbers.