Could Bitcoin Be the Biggest Pump-and-Dump Scheme of All Time?
Bitcoin is at record highs and largely concentrated in the hands of a few. These “Bitcoin Whales” possess immense power. If the 86 whales – who own approximately 14% of all existing bitcoins – decided to collude in an elaborate pump-and-dump scheme, they could erase a large percentage of bitcoin’s value. That sell off would be worth approximately $130 billion. For context, bitcoin’s current market cap is a little over $1 trillion, which is comparable to Tesla ($TSLA).
Pump-and-Dump Schemes and Bitcoin
We’ve talked about pump-and-dump schemes in the context of retail investors colluding to take down hedge funds. They are more traditionally employed, however, to boost the price of a stock or other security through fake recommendations. In these cases, the perpetrators will hold a position in the target stock/security and then communicate misleading, false, or greatly exaggerated claims about the target, hoping to generate buying interest. Once the hype has led to a higher sale price, the perpetrators sell.
The U.S. Securities and Exchange Commission (“SEC”) brings enforcement actions for these cases regularly, as illustrated here and here. Illicit gains are usually only a few million dollars at most. They do not have jurisdiction over the spot market for bitcoin, however (it’s not a “security”). Their involvement in regulating cryptocurrencies is generally limited to Initial Coin Offerings or “ICOs.”
No other U.S. or foreign regulator has direct authority to regulate the bitcoin spot market either. What this means is that it is open season for bitcoin market participants to engage in almost any activity they would like. Drive prices up by placing fake bids? No problem. Collude with other whales to profit at the expense of average market participants? No issue. In fact, it should shock no one that there have been documented cases of bitcoin market manipulation. Yet no criminal or civil enforcement manipulation cases have been brought to date.
In the case of the whales, one might foresee a scenario where they come together and agree to collectively offload their positions, in full or in part. Split 86 ways, their $130 billion share would result in paydays of about $1.5 billion per whale. The best part of it all for them? They basically could do it with impunity.
How Would Prosecutors or Regulators Respond?
No regulator or law enforcement agency in any jurisdiction would really have the authority to bring a case. The U.S. might try if the whales converted their holdings to USD, thus giving them a jurisdictional hook, but there are no current laws specific to cryptocurrencies. An antitrust case would be difficult to bring. It would be like trying to take down OPEC. Wire fraud may be a good option, but proving the “fraud” would be next to impossible. Why couldn’t the whales sell their existing holdings? So what if they coordinated to do it? WallStreetBets traders do it everyday and the SEC made it clear there is nothing to see there. And that’s in much more heavily regulated equities and options markets.
Dumping to Pump
If the Bitcoin Whales were to coordinate a mass sell off, the bitcoin price would drop significantly. It might even seriously spook the market, at least temporarily, and cause a “Bitcoin Run” where investors rush to sell off their coins. With price shocks impacting the market, and many investors looking to sell, the whales would have no problem buying bitcoin for substantially lower prices than where they sold. Sell high, buy low. Wait for the market to correct.
What I’ve described is a variation of a pump-and-dump scheme. The whales may not have played the classic perpetrator role of pumping up the bitcoin market. They don’t need to though. The market as of this writing is at all time highs.
In this scenario, they would effectively dump to pump. Offload their positions, which might take some time given liquidity constraints. Once word got out, many other market participants would inevitably rush to sell to avoid losses. Then the whales could buy in again towards the bottom while everyone else is trying to sell.
The Need for Bitcoin “Insiders”
While this scenario is far more likely in a more esoteric cryptocurrency that’s easier to pump-and-dump, it should give bitcoin investors pause that so much ownership is concentrated at the top with so little regulation protecting the market. That is to say, no regulation. If these were securities, anyone holding 10% or more would be deemed an “insider” and required to “report purchases, sales, and holdings of their company’s securities.” Crypto markets have no equivalent rule.
Satoshi Nakamoto could dump all 1 million of his/her/they/its alleged bitcoin holdings without any consequence. No disclosure necessary. Although Satoshi’s 1 million bitcoins may not technically be 10% of total supply (approximately 18.864 million), when considering the number of lost bitcoins and inactive accounts, a sale of 1 million bitcoins would have significant market impact.
Which is why any regulator devising “insider” rules for bitcoin should not use total supply as an absolute measure. They should also consider the number of bitcoins in active circulation by assessing activity on various exchanges. Coinbase, for example, has approximately 50% of the bitcoin market share and over the last 30 days saw volume of approximately 481,000.
Preventing a Bitcoin Pump-and-Dump Scheme
Many may think it’s an unlikely risk. Yes, it would take time for all whales to offload their positions. It could not be done overnight. But it could be done. And there is no coordinated global enforcement that could do anything about it.
Unlike other asset classes, bitcoin trading never stops. The market never sleeps. Even foreign exchange takes the weekend off. This makes bitcoin a truly unique market of an extraordinarily global nature. And given the relative “anonymity” of the blockchain, whales could be anywhere in the world.
While it is unlikely that all 86 whales would even be able to identify each other to pull off an elaborate scheme of this magnitude, the potential exists. With no deterrent in place, a pump-and-dump type scheme should be a consideration for any serious bitcoin investor. Until regulators react to the inherent manipulation risk in this market, it is open season. Buyer beware.
