It is striking how cryptocurrencies are both similar and dissimilar to the more established asset classes at the same time. On the one hand, many findings from traditional asset classes also apply to this novel class. On the other hand, this “new” world with its own characteristics brings many novel “problems” that attract researchers. This week’s blog presents several research papers connected to the pump and dump schemes in cryptos. These pumps and dumps are nothing new, and we already know them from the stock market. However, there are some notable differences. In the stock market, manipulators tend to persuade other investors that they have private information and the stock is deeply undervalued. In cryptos, the situation is different. There are private and organized anonymous “pump” groups (using apps such as Telegram) where the administrators announce that at a given time and cryptocurrency exchange, they are gonna pump some (unknown to the public at that time) cryptocurrency. There is no claim that the crypto is undervalued, and it might appear purely speculative. This strategy allows for two key things: firstly, the manipulators can buy the cryptos in advance of the pump, allowing them to dump it to gain a profit, and secondly, other participants can transfer fund to the given exchange to be ready for the pump that is announced as the name of the crypto later. Moreover, the administrator might even offer “private” and paid information and might share the name of cryptocurrency in advance. As the research papers show, it is crucial to buy the currencies before the pump starts since the pumps are connected with negative expected returns.
With negative expected returns and the zero-sum game attribute of these pump and dump schemes, why would anyone want to participate in these speculations? According to the research, people are attracted to the gambling, excitement and expectations of big profits in a short time connected with these schemes. Additionally, they overestimate their abilities to time the pumps and dumps. People also might believe that they are the “fast” ones, and there would be slower buyers that will buy the crypto they are already dumping.
The general insights are excellent examined in the papers of Li, Shin and Wang (2021) and Dhawan and Putniņš (2020). Furthermore, Xu and Livshits (2019) research paper even study the possibility to predict the pumps and dumps. Using various features such as market cap, multiple volumes and returns, number of previous pumps or some sort of crypto rating, authors try to predict pumps in future using random forests and generalized linear models. Although the prediction accuracy is far from perfect, it might be interesting to build on this research and dive deeper. Given the scarcity of regulations in crypto markets, such schemes can be only hardly eliminated.
Authors: Anirudh Dhawan and Tālis J. Putniņš
Title: A New Wolf in Town? Pump-and-Dump Manipulation in Cryptocurrency Markets
We show that cryptocurrency markets are plagued by pump-and-dump manipulation, with at least 355 cases in seven months. Unlike stock market manipulators, cryptocurrency manipulators openly declare their intentions to pump specific coins, rather than trying to deceive investors. Puzzlingly, people join in despite negative expected returns. In a simple framework, we demonstrate how overconfidence and gambling preferences can explain participation in these schemes and find strong empirical support for both mechanisms. Pumps generate extreme price distortions of 65% on average, abnormal trading volumes in the millions of dollars, and large wealth transfers between participants. These manipulation schemes are likely to persist as long as regulators and exchanges turn a blind eye.
Visit Quantpedia to read the full article:
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from Quantpedia and is being posted with permission from Quantpedia. The views expressed in this material are solely those of the author and/or Quantpedia and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
Disclosure: Bitcoin Futures
Trading in Bitcoin futures is especially risky and is only for clients with a high risk tolerance and the financial ability to sustain losses. More information about the risk of trading bitcoin products can be found on the IBKR website.If you’re new to bitcoin, or futures in general please visit CME Bitcoin Futures.
PLEASE NOTE AT THIS TIME INTERACTIVE BROKERS PROVIDES LIMITED ACCESS TO CRYPTO-RELATED PRODUCTS. ELIGIBILITY TO TRADE IN CRYPTO-RELATED PRODUCTS MAY VARY BASED ON JURISIDICTION. TRADING IN CRYPTO-RELATED PRODUCTS IS ESPECIALLY RISKY AND IS ONLY FOR CLIENTS WITH A HIGH RISK TOLERANCE AND THE FINANCIAL ABILITY TO SUSTAIN LOSSES.