Cryptocurrency markets have long been scrutinized for potential fraudulent activities, with pump and dump schemes being a persistent concern. Pump and dump schemes are well-known tactics in the crypto space. They involve strategic investment, heavy promotion, and subsequent mass selling to capitalize on inflated prices.
A recent analysis by Chainalysis in its annual Crypto Crime Report delves into the intriguing intersection of ERC-20 tokens, decentralized exchanges (DEXes), and suspicious trading patterns on the Ethereum network. ERC-20 is the technical standard for exchangeable tokens created using the Ethereum blockchain. While 54 percent of these tokens display potential signs of pump and dump schemes, they contribute merely 1.3 percent to the overall trading volume on DEXes.
Methodology
In its annual Crypto Crime Report, Chainalysis’s research focuses on the transfer of funds to ransomware operators, darknet markets, or sanctioned entities. Chainalysis’s methodology focused on decentralized finance (DeFi) due to its transparency, utilizing on-chain data to uncover potential market manipulation patterns.
Specifically, the research examines the Ethereum network, which has undergone rapid growth and innovation in recent years. The presence of the ERC-20 standard within the ecosystem has facilitated the seamless creation of new tokens on the Ethereum platform. Therefore, all these tokens can be easily traded with one another and utilized across various decentralized applications.
Ethereum landscape
The Ethereum network, with its ERC-20 standard, provides an ideal environment for creating and trading tokens. The ease of token creation, however, has led to a crowded marketplace, making it challenging for new tokens to gain substantial liquidity. In fact, between January and December 2023, over 370,000 tokens were launched on Ethereum. 168,600 of them are available on DEXes. Therefore, a decline in liquidity values, coupled with increasing monthly token launches, suggests the challenge of standing out in a saturated market. Moreover, it increases the instances of fraudulent activity such as pump and dump schemes.
However, not all of these tokens gain traction. Fewer than 14.1 percent of them achieve more than $300 of DEX liquidity per month. Moreover, only 5.7 percent of tokens launched in 2023 are currently above that threshold. Therefore, low liquidity values suggest that the majority of these tokens still cannot be easily exchanged with liquid assets without having their prices significantly affected.
Pump and dump schemes
Various factors may contribute to the challenge of achieving higher trading volumes, especially as the tokenization trend gains popularity and introduces new tokens to an already saturated market. One potential explanation for the struggle to attain more liquid trading volumes involves instances of pump and dump schemes. Here is an example of how pump and dump schemes are executed:
An individual or a group of actors initiates the launch of a new token or acquires a substantial portion of the supply for an existing token, typically one with historically low trading volume. Then, the actor(s) promotes the token aggressively, portraying it as a lucrative opportunity for rapid wealth accumulation. Consequently, persistent marketing efforts on social media and chat platforms attract user attention, resulting in increased buying activity. In some cases, the actor may engage in wash trading, a practice involving simultaneous buying and selling of the same asset to artificially inflate its trading activity.
If the manipulation is successful, the token’s value experiences a surge. Once the token reaches the desired price target, the actor liquidates their position, securing a profit. Subsequently, the token’s price rapidly declines due to heightened selling pressure, leaving many investors with significant losses. If the actor is also the creator of the token, they might abandon the project entirely, executing a “rug pull” and absconding with additional funds from users.
Identifying pump and dump schemes
In its analysis, Chainalysis employed Transpose to identify ERC-20 tokens meeting specific criteria, denoted as “Criteria A.” These criteria included:
- The token is purchased at least five times on decentralized exchanges (DEX) with no on-chain connection to the token’s largest holders, indicating a certain level of market traction.
- A single address removes over 70 percent of the liquidity in the token’s DEX liquidity pool. This signals a substantial sell-off by the largest holder which typically occurs within the initial weeks of launch.
- The token presently has a liquidity value of $300 or less. This suggests a near cessation of the token’s market activity following the removal of liquidity. If the token was associated with multiple DEX pools, Chainalysis aggregated the liquidity.
Using this criteria, Chainalysis revealed that around 90,408 tokens met Criteria A. They constituted 24.4 percent of all tokens launched on Ethereum and 53.6 percent of tokens listed on a DEX. Despite the significant number, the volume of transactions involving tokens meeting Criteria A in 2023 only accounted for 1.3 percent of the total trade volume on Ethereum DEXes.
However, this methodology doesn’t automatically designate these tokens as subjects of pump and dump schemes. Instead, it serves as a demonstration of how operators or regulators can use on-chain trading data to identify and prioritize patterns that might indicate illicit activities.
Additionally, the trend in the monthly count of new tokens meeting Criteria A indicates a decline since mid-2023. However, it revealed an increase compared to 2022. This decline may suggest various possibilities, such as changes in market dynamics, regulatory interventions, or heightened awareness among market participants. Hence, the ongoing monitoring and analysis of such trends are crucial for staying informed about the evolving landscape of token activities on the Ethereum network.
Token profits
The study reveals that the actors who launched tokens meeting Criteria A collectively generated an estimated profit of approximately $241.6 million in 2023. It’s important to note that this figure does not include other associated costs involved in building and launching these tokens. Despite the substantial total profit, the average profit per individual token meeting the criteria is relatively modest, amounting to just $2,672. Moreover, these tokens collectively contributed only 1.3 percent to the total Ethereum DEX trading volume for 2023.
This data provides insight into an ecosystem where potential bad actors may create a large number of tokens with the potential for pump and dump schemes. However, the majority of these tokens failed to generate significant profit and did not attract meaningful trading volume. Therefore, the findings underscore the importance of monitoring and addressing potential manipulative activities to maintain the integrity of the cryptocurrency market.
Read: 5 digital habits to stay cyber-safe in 2024
Market patterns
Market manipulation, including pump and dump schemes, poses a threat to the crypto markets’ integrity. However, the inherent transparency of cryptocurrency offers opportunities to build safer markets. Monitoring tools like Transpose can be instrumental in identifying unusual on-chain activities and providing actionable leads for further investigation.
As the crypto space continues to evolve, addressing market manipulation becomes crucial for maintaining market stability and investor trust. Chainalysis’s analysis sheds light on the prevalence of potential pump and dump schemes in the ERC-20 token space. It emphasizes the importance of vigilance, transparency, and collaborative efforts to ensure the integrity of decentralized finance.
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