Buyer beware: How to spot (and avoid) rug pulls and pump-and-dump schemes

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Don’t fall for their tricks.

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If you’re an active investor who dabbles in penny stocks or cryptocurrencies, you may be aware of two similar types of scams: the pump-and-dump stock scheme and the crypto rug pull. If you’ve ever fallen for one, you might feel like the entire market is a rigged game with you as the target.

It’s not, but there are bad actors out there looking to relieve you of your hard-earned money. Plus, in the age of social media—and with the rise of cryptocurrency—pump-and-dump scams and rug pulls can happen more frequently, and quickly.

Don’t be frightened; be educated, and be savvy. Learn to recognize the warning signs to ensure that you’re well-equipped to avoid them. You don’t want to be the one left holding the bag.

A pump-and-dump scheme happens when the price of an asset is “pumped” through deceptive means (often by a group of insiders working as a team), then the asset is “dumped” while the price is still high. A rug pull occurs when a crypto project developer suddenly withdraws all the funds from the project, essentially “pulling the rug” out from under investors who are left with worthless tokens.

How do pump-and-dump schemes really happen? Why are rug pulls possible? Here are six factors that contribute to the occurrence of these types of schemes.

1. Low liquidity. Assets with low liquidity are easier to manipulate because it doesn’t take much volume to drive their prices significantly higher. This makes such assets (penny stocks being a great example) prime targets for fraudulent actors.

2. Volatile market conditions. High market volatility can create ideal circumstances for price manipulation or the sudden withdrawal of funds.

3. Social media hype. Pump-and-dump scammers need to generate hype to inflate asset prices; rug pull scammers need to attract liquidity. Much of this hype is generated on social media.

4. Sophisticated marketing. Beyond the hype on social media, pump-and-dump schemes and rug pulls may be executed with the help of sophisticated marketing. Scammers may use professional-looking websites and marketing materials to appear legitimate. They may even pose as analysts representing top investment banks.

5. Low regulatory oversight. Assets like meme coins and penny stocks may not be well regulated, making it easier for scams to be carried out before regulators take notice.

6. FOMO. “This stock is the next NVIDIA!” “Our token is the next generation of blockchain technology and by next year we’ll replace Ethereum!” The fear of missing out can contribute to the success of pump-and-dump schemes and rug pulls. Investors who are eager to gain exposure to the “next big thing” may fail to conduct the proper due diligence.

Becoming a victim of a rug pull or pump-and-dump scheme is possible—but not inevitable. Some best practices can help:

You know the saying about something that seems too good to be true—it probably is! Beware of unrealistic promises.

Because speculative assets like meme stocks, penny stocks, and meme coins are so often the target of pump-and-dumps and rug pulls, you may be wondering whether any exposure to these assets is advisable.

The answer is—it depends. Should you invest all your funds in the riskiest assets that promise the highest returns? Probably not. But might you use a conservative amount of your portfolio to speculate? Maybe. That depends on your objectives and risk tolerance.

A well-diversified portfolio typically holds a range of investments that span asset types. Stocks, bonds, exchange-traded funds or mutual funds, cryptocurrency, and real estate may all be included in a diversified portfolio. Diversification generally raises your risk-adjusted return profile, allowing you to consider allocating a conservative percentage—perhaps 5% or 10%—into assets with high risk and high growth potential. To speculate, or not to speculate: That is the question only you can answer!

Always make sure to conduct plenty of research before making any investment decisions. Pump-and-dump schemes and rug pulls can and do happen, but getting and staying informed is a powerful way to protect yourself. If you’re driven to speculate, go forth with caution—and don’t invest more than you’re comfortable losing.