Pumping and Dumping in the Information Age
The “pump and dump” as well as other market manipulation tactics have been around since the advent of the stock market. In a pump and dump scheme, fraudsters artificially inflate prices of a stock by using cold calls, newspapers, and other forms of media to publish exaggerated, misleading, or false statements about the prospects of a stock. As soon as the fraudsters “dump” the stock by selling off their shares, the price of the stock soon plummets, leaving investors with pennies.
Jordan Belfort, who was portrayed in the hit movie “The Wolf of Wall Street”, is perhaps the most famous perpetrator of the “pump and dump” scheme. As the co-founder of a penny-stock brokerage called Stratton Oakmont, Belfort bought small-cap stocks and used his army of brokers to push these stocks onto unsuspecting clients through telemarketing. The emergence of the Internet has offered cheaper and easier ways to mass advertise small-cap stocks, and more recently, cryptocurrencies.
Elon Musk, known for his outspoken nature on Twitter, has been shown to have a tremendous influence on the prices of cryptocurrencies like Bitcoin or Dogecoin. When Musk tweeted that “Tesla would no longer accept bitcoin as payment due to environmental concerns about its heavy energy use..the price of bitcoin dropped around 15 percent” (Molla). When Musk followed by tweeting that “Tesla would again accept bitcoin once miners moved to ‘reasonable’ clean energy usage…the cryptocurrency’s price [went] up 8 percent” (Molla). And finally, when Musk “tweeted a meme about breaking up with bitcoin..the price of bitcoin declined 5 percent” (Molla). While Musk has not been “pumping” the price of Bitcoin for financial gain, he undoubtedly impacts and influences crypto prices in tangible and measurable ways.
While Elon Musk appears to have been “pumping” prices without any malign intentions, other social media influencers have been involved in “pumping and dumping” small-cap cryptocurrencies, otherwise known as altcoins. Cryptocurrencies, due to their unregulated nature, have become a breeding ground for market manipulation.
Most notably, members of Faze Clan, a group of social media influencers famous for producing gaming videos, promoted a charitable cryptocurrency project called “Save the Kids.” However, hours after its launch, “its value crashed” with many calling it a “pump and dump” (Britton). Social media influencers are particularly powerful in swaying the prices of cryptocurrencies, due to their often young and impressionable audience (Britton). This case is not unique: “according to a report this year by the Federal Trade Commission..more than 80 million has been lost in crypto-related scams since October 2020” (Britton).
But why do big influencers like Elon Musk or members of Faze Clan have such influence over financial markets, despite their lack of expertise in cryptocurrencies or stocks? And how do market manipulation tactics work in the first place?
Many of these questions can be answered within the lens of information cascades. Many people receive a mixed series of signals from the outside world about particular stocks or cryptos. Certain signals, like Elon Musk or Youtubers tweeting about cryptos, appear to be more trustworthy than others simply by nature of the popularity of the influencer and the familiarity that people have with them. In other pump and dump schemes, telemarketers often claimed to have some secret inside information about the company. Once someone follows the advice or private signal of a big social media influencer or telemarketer and buys in on a cryptocurrency, a public signal is sent out across the world when the price of a cryptocurrency or stock jumps a minuscule amount. This leads to an information cascade, as people ignore other signals (including very reputable sources like accounting sheets, financial analysis papers, or even their own intuition) and follow suit. As discussed in the lecture, information cascades can be very easy to start and arise based on little information–and modern-day market manipulation tactics rely on people to “follow the crowd.” People fallaciously ignore simple accounting, math, and probability in favor of pursuing the crowd. The madness of crowds is well documented in a multitude of stock books, where people, who fear missing out on potentially life-altering financial gain, forgo their own carefully done financial analysis in favor of a rampaging horde.
Sources:
https://www.nbcnews.com/tech/tech-news/wild-west-cryptocurrencies-social-media-influencers-rcna1469 https://www.vox.com/recode/2021/5/18/22441831/elon-musk-bitcoin-dogecoin-crypto-prices-tesla