Ask CryptoVantage: Is Bitcoin a Pump and Dump Scheme?

How Pump and Dump Schemes Work

A typical pump and dump scheme occurs when a group of people hold a large amount of an asset and they work together to drive up the price of the asset by buying it at higher prices and hyping it up.

The price movements and hype around the asset draws attention from outside investors who then buy the asset because of fear of missing out. As a result of the outside investors buying the asset, the price goes up even further at which point the coordinators of the pump and dump scheme sell off their holdings at a large profit. This then causes the price of the asset to crash. The result of the pump and dump is that the insiders end up with more cash, and the outside investors are left holding an asset that is now worth less than what they bought it for.

Hype

One of the classic signs of a pump and dump scheme is that there is a relatively small group of people who are promoting an asset. Because bitcoin is a new technology, there is still a small group of people that are involved with it. And because of bitcoin’s potential to make our monetary system more fair, this small group of people promote it very strongly. To an outsider, this could look like a pump and dump scheme.

Just like with pump and dump schemes, there is a large number of outside investors who have started investing in bitcoin as a result of the price increases and the hype around the technology. These investors are drawn to bitcoin for the same reasons they might be drawn to a pump and dump scheme, and the influx of new investors is contributing to the price increase. It is important to remember that these things alone do not make bitcoin a pump and dump scheme. Bitcoin ownership is distributed widely across many investors around the world, which makes it very hard for a group of people to control price movements.

Rapid Price Increases

Another property of pump and dump schemes is rapid increases in price. Bitcoin’s price has increased by 250% in the past five months, which has potential investors worried that the price is being pumped up so that bitcoin holders can dump their holdings. It is easy to believe this if you are not familiar with both macroeconomics and bitcoin’s monetary policy. Once you understand these topics it becomes pretty clear that bitcoin’s price increase is not part of a pump and dump scheme. In fact, bitcoin has seen rapid price increases many times over its twelve-year existence. In 2017, for example, the price of bitcoin increased 700% over five months. Before that, the price increased by 600% in just two months in 2013.

Unlike a pump and dump scheme, bitcoin has continually increased in price even after major price corrections. Even though bitcoin has had major price corrections, the overall trend is still increasing through time, which would not be true of a pump and dump scheme.

If bitcoin’s rapid price increase is not due to a pump and dump scheme, then what is it caused by? The two main factors are simple:

• Bitcoin’s fixed supply is being met with increased demand. Even though bitcoin’s supply is fixed and unchangeable, demand for it increases steadily through time as more people learn about it and the benefits it provides. A fixed supply with increasing demand results in an increasing price. This phenomenon has been true for all of bitcoin’s twelve-year existence.
• The current macroeconomic landscape is creating the perfect storm for investors to buy and hold bitcoin for the long term. Because of the state of the economy, in large part due to the economic response to COVID-19, there has been a recent influx of corporations and wealthy individuals who have been buying and holding large amounts of bitcoin. Low interest rates, expectations of high inflation, and the de-risking of bitcoin due to companies like Tesla buying it, have created the perfect storm for these types of investors to buy bitcoin. These types of investors have huge amounts of cash, so when they make an allocation to bitcoin, it can have a significant impact on the price.