- Cryptocurrency is less regulated than other assets, which can lead to scams, fraud, and financial ruin.
- There are various forms of crypto market manipulation, including pump-and-dump schemes and rug pulls.
- Investors can avoid several common crypto scams by performing thorough due diligence before trading.
A cryptocurrency is a digital token that can be exchanged for goods and services. But many retail investors and institutions treat cryptos as investments instead of means of exchange, buying certain coins and hoping to sell them for a profit at a later date.
But investors must be careful before dabbling in these widely misunderstood assets.
Cryptocurrencies are speculative by nature. They lack traditional fundamentals that investors can analyze and assign value to. As a result, cryptos tend to be volatile assets — their prices can drastically fluctuate on any given day. Crypto markets are also less regulated in general, so it's easier for bad actors to maliciously influence prices and take advantage of unsuspecting investors.
For these reasons, investors should be wary of the following crypto scams before they start investing in crypto.
1. Market manipulation
Market manipulation is the deliberate attempt to artificially influence or interfere with asset prices. Typically, scammers manipulate markets to tip the scales in their favor and make quick returns. Several illicit trading activities fall under this umbrella term, including:
- Spoofing: This creates an illusion of momentum by placing fake buy or sell orders, which are canceled before they're filled. Scammers frequently use dummy accounts and bots to place large trades, giving other investors the impression that demand is either increasing or decreasing.
- Front-running: This is the practice of making trades based on knowledge of future transactions. For instance, miners or node operators can have insight into pending trades. They could then leverage their inside access to make profitable trades ahead of major price swings.
- Churning: This is excessive trading by a broker in a client's crypto account to generate additional commissions. Asset management firms can receive fees for managing crypto holdings. Therefore, nefarious brokers could abuse a commission-based payment structure to profit off of unaware clients. On top of unwarranted fees, the impacted individuals could also incur unnecessary tax liabilities as a result of churning.
Since cryptocurrency markets are still relatively new and less regulated, they're more vulnerable to market manipulation. However, there are ways crypto traders can avoid falling victim to these scams.
For starters, it's best to trade on larger, reputable exchanges that have established security policies and internal controls. Additionally, investors can safeguard against unlawful tactics in the crypto markets by thoroughly researching coins, brokers, and exchanges before making any financial decisions. For instance, legitimate cryptos and companies typically offer potential investors an abundance of learning materials on their websites.
Quick tip: Although plenty of investors day trade crypto, market manipulation usually impacts short-term trading activity. So, you can help protect against spontaneous price jumps by adopting a long-term outlook, otherwise known as "HODL-ing." This stands for "hold on for dear life" and encourages a buy-and-hold investing strategy.
2. Pump-and-dump schemes
A pump-and-dump scheme represents an individual or group's effort to inflate the price of an asset so that they can sell their own holdings for a profit.
It starts with the "pump." To convince people to buy in, crypto schemers spread false or misleading information about minimally traded coins through social media, forums, and online communities. These posts often contain embellished due diligence (or "DD") and promise an impending surge. They'll use emojis like rocket ships paired with moons and diamonds alongside outstretched hands, implying an investment is about to pop and that investors should buy and hold.
Then comes the dump. As momentum swells, other investors cash in and drive the price up, while the schemers cash out and make a quick fortune. Once the market realizes the hype was fake, investors scurry to limit losses and the coin's price plummets.
Spotting a pump-and-dump scheme boils down to credibility. If you use social media platforms like Reddit and Twitter to track crypto movements, look out for anonymous accounts with minimal posting history — or a track record of baseless pumping. These are likely fraudsters.
3. Rug pulls
A rug pull occurs when crypto developers abandon a project but keep the funds raised from investors. Bad actors can list a new token on a decentralized exchange, pair it with a legitimate cryptocurrency, and drum up interest on social media to lure in investors. Once enough money funnels into their token, the developers scratch the project and run with investor funds.
This scam plagues early investors who think they're getting early access to up-and-coming cryptos, when in reality they're scammed out of their money. "If it sounds too good to be true, it probably is," explains Shaun Heng, the VP of Growth & Operations at CoinMarketCap, one of the most frequented websites for tracking crypto prices.
"Pay close attention to the websites and third parties involved. Don't rely on comments from anyone on social media, no matter what people are saying or how many positive reviews there are. If you can't find verifiable reviews, the chances of the opportunity being a scam are higher," Heng adds.
Quick tip: By sticking to centralized cryptocurrency exchanges, which typically have stricter oversight and regulations, you have a better chance of avoiding illegitimate projects.
4. Traditional hacking and theft
Crypto markets have unique characteristics relative to other asset markets. But investors are still susceptible to traditional scams like account hacks and identity theft.
To trade crypto, investors need a crypto wallet, which can be a digital or physical device. These wallets have keys — both public and private. The former is a public address that allows crypto to be deposited into the wallet, similar to how routing and bank account numbers enable direct deposits. The latter is like the password to an online banking platform. Whoever has access to that password can control the funds within the account.
Just as you wouldn't share your credit card number with a stranger, keep your private keys somewhere safe. Fraudsters can use this information to hack accounts and withdraw funds — and they'll employ various tricks to get investors to reveal their private information.
Be cautious of crypto phishing emails that may pose as a crypto exchange or wallet provider. The same goes for out-of-the-blue and unsolicited promotions from suspicious websites and imposter accounts. Scammers often pretend to be celebrities or affiliates of major companies, promising guaranteed and immediate returns if you act quickly.
Quick tip: To avoid accidentally falling for phishing emails, verify that the sender's email address is valid and/or recognizable. Often, scammers use addresses with generic domains and random characters.
5. Initial coin offering (ICO) scams
An initial coin offering (ICO) is the crypto equivalent of an initial public offering (IPO) for a stock. Through an ICO, companies can raise money to fund a crypto development, such as a token, app, or relevant service. In exchange for pledging funds, the investor receives an issuance of newly minted coins.
While IPOs are typically for well-established private businesses, companies that pursue ICOs aren't necessarily in the same position. They could be fledgling startups without any operating history whatsoever, which can make it difficult to differentiate between a real offering and a scam. Similar to rug pulls, ICO scams collect the funds of early investors only to abandon the project shortly after.
An easy way to recognize an ICO scam — or simply an unprepared management team — is to review the company's whitepaper. This document details the specifications behind the project, including strategy, goals, and market analysis. If the company doesn't provide a whitepaper, that's a red flag.
Quick tip: You can perform a background check on the ICO's developers and management team. If the company's ownership is anonymous or has a minimal track record in the crypto space, that should also be a cause of concern.
The financial takeaway
Decentralized finance can be a Catch-22. On one side, the lack of a singular governing body allows community-wide decisions and can open the doors to additional opportunities. On the other side, without standardized oversight, bad actors can commit fraud and deceive unsuspecting investors in a variety of ways.
However, much like in traditional asset markets, crypto investors can lower their risk of succumbing to market manipulation by being wary of these schemes and taking proactive measures. That includes using reputable exchanges and performing thorough research before making any investment decisions. If you come across a scam, you can report it to the Federal Trade Commission at ReportFraud.ftc.gov.