- Cryptocurrency is less regulated than other assets, which can lead to scams, fraud, and financial ruin.
- There are various forms of crypto market manipulation, including pump-and-dump schemes and rug pulls.
- You can avoid several common crypto scams by performing due diligence before trading.
A cryptocurrency is a digital token that can be exchanged for goods and services. However, many retail investors and institutions treat cryptos as investments instead of means of exchange, buying certain coins and hoping to sell them for a profit at a later date.
As with any asset, investors must be careful before dabbling in crypto. Crypto investments are prone to scams, in part because they are new and generate a lot of buzz that can rope people into schemes that they should, in reality, avoid.
Plus, cryptocurrencies are speculative by nature. They lack traditional fundamentals that investors can analyze and assign value to. As a result, cryptos tend to be volatile assets — their prices can drastically fluctuate on any given day. That can make it hard to discern what's being manipulated unfairly and what's normal swings.
Crypto markets are also less regulated in general, so it's easier for bad actors to maliciously influence prices and take advantage of unsuspecting investors.
That's not to say that all crypto investments are dangerous, but investors should be wary of the following common types of crypto scams before they start investing in crypto.
Common types of crypto scams
Crypto scams can take many forms, some of which also happen with assets like stocks, while some are more unique to crypto.
Namely, crypto investors should watch out for scams such as:
Rug pulls
A rug pull occurs when crypto developers abandon a project, such as a new cryptocurrency or non-fungible token (NFT) but keep the funds raised from investors. Bad actors can list a new token on a decentralized exchange, pair it with a legitimate cryptocurrency, and drum up interest on social media to lure in investors. Once enough money funnels into their token, the developers scratch the project and run with investor funds.
This scam plagues early investors who think they're getting early access to up-and-coming cryptos, when in reality they're scammed out of their money.
To avoid this, watch for warning signs like unrealistic/overly grand promises, anonymity from developers, and a general lack of transparency.
Quick tip: By sticking to centralized cryptocurrency exchanges, which typically have stricter oversight and regulations, you have a better chance of avoiding illegitimate projects.
Pump-and-dump schemes
A pump-and-dump scheme represents an individual or group's effort to inflate the price of an asset so that they can sell their own holdings for a profit.
It starts with the "pump." To convince people to buy in, crypto schemers spread false or misleading information about minimally traded coins through social media, forums, and online communities. These posts often contain embellished due diligence (or "DD") and promise an impending surge. They'll use emojis like rocket ships paired with moons and diamonds alongside outstretched hands, implying an investment is about to pop and that investors should buy and hold.
Then comes the dump. As momentum swells, other investors cash in and drive the price up, while the schemers cash out and make a quick fortune. Once the market realizes the hype was fake, investors scurry to limit losses and the coin's price plummets.
Spotting a pump-and-dump scheme boils down to credibility. If you use social media platforms like Reddit and Twitter to track crypto movements, look out for anonymous accounts with minimal posting history — or a track record of baseless pumping. These are potentially fraudsters. Also, consider if there are sudden, unexplained price spikes. And if the crypto has no apparent real-world value or utility, it could be a pump-and-dump scheme.
Other market manipulation scams
Market manipulation is the deliberate attempt to artificially influence or interfere with asset prices. While pump and dump is perhaps the best-known type of market manipulation scam, there are several other illicit trading activities that fall under this umbrella term, including:
- Spoofing: This creates an illusion of momentum by placing fake buy or sell orders, which are canceled before they're filled. Scammers frequently use dummy accounts and bots to place large trades, giving other investors the impression that demand is either increasing or decreasing.
- Front-running: This is the practice of making trades based on knowledge of future transactions. For instance, miners or node operators can have insight into pending trades. They could then leverage their inside access to make profitable trades ahead of major price swings.
- Churning: This is excessive trading by a broker in a client's crypto account to generate additional commissions. Asset management firms can receive fees for managing crypto holdings. Therefore, nefarious brokers could abuse a commission-based payment structure to profit off of unaware clients. On top of unwarranted fees, the impacted individuals could also incur unnecessary tax liabilities as a result of churning.
Since cryptocurrency markets are still relatively new and less regulated, they're more vulnerable to market manipulation. However, there are ways crypto traders can avoid falling victim to these scams.
For starters, it's best to trade on larger, reputable exchanges that have established security policies and internal controls. Additionally, investors can safeguard against unlawful tactics in the crypto markets by thoroughly researching coins, brokers, and exchanges before making any financial decisions. For instance, legitimate cryptos and companies typically offer potential investors an abundance of learning materials on their websites.
Quick tip: Although plenty of investors day trade crypto, market manipulation usually impacts short-term trading activity. So, you can help protect against spontaneous price jumps by adopting a long-term outlook, such as using a buy-and-hold investing strategy.
Fake ICOs (initial coin offerings)
An initial coin offering (ICO) is the crypto equivalent of an initial public offering (IPO) for a stock. Through an ICO, companies can raise money to fund a crypto development, such as a token, app, or relevant service. In exchange for pledging funds, the investor receives an issuance of newly minted coins.
While IPOs are typically for well-established private businesses, companies that pursue ICOs aren't necessarily in the same position. They could be fledgling startups without any operating history whatsoever, which can make it difficult to differentiate between a real offering and a scam. Similar to rug pulls, ICO scams collect the funds of early investors only to abandon the project shortly after.
An easy way to recognize an ICO scam — or simply an unprepared management team — is to review the company's whitepaper. This document details the specifications behind the project, including strategy, goals, and market analysis. If the company doesn't provide a whitepaper, that's a red flag. Also, if the whitepaper is unrealistic or there's a general lack of vision for how the ICO will go and how the coin will be used, those are all warning signs.
Quick tip: You can perform a background check on the ICO's developers and management team. If the company's ownership is anonymous or has a minimal track record in the crypto space, that should also be a cause of concern.
Cyber scams
Crypto markets have unique characteristics relative to other asset markets. However, investors are still susceptible to traditional scams, such as account hacks and identity theft.
To trade crypto, investors need a crypto wallet, which can be a digital or physical device. These wallets have keys — both public and private. The former is a public address that allows crypto to be deposited into the wallet, similar to how routing and bank account numbers enable direct deposits. The latter is like the password to an online banking platform. Whoever has access to that password can control the funds within the account.
Just as you wouldn't share your credit card number with a stranger, keep your private keys somewhere safe. Fraudsters can use this information to hack accounts and withdraw funds — and they'll employ various tricks to get investors to reveal their private information.
In particular, be cautious of crypto phishing emails that may pose as a crypto exchange or wallet provider. The same goes for out-of-the-blue and unsolicited promotions from suspicious websites and imposter accounts on social media. Scammers often pretend to be celebrities or affiliates of major companies, promising guaranteed and immediate returns if you act quickly.
Like with other types of cyber attacks, however, the goal of the fraudsters with cyber phishing scams or social media scams is to simply trick you into giving up sensitive information that they can use to drain your funds.
Spotting phishing scams is tricky, because cybercriminals often go to great lengths to make them look real, like setting up websites that mimic real ones to get you to enter your keys for them to then take. So, look closely at information like the URL of any links, and watch for things like spelling mistakes in emails or an unexpected request for personal information. It's generally better to take your time and investigate even if you get an email that's urgently requiring you to take action.
With social media and other online scams, also watch for warning signs like getting unrealistic promises of returns or requests to send you crypto, which is really just a way to infiltrate your wallet. And in general, be wary of unsolicited messages.
Quick tip: To avoid accidentally falling for phishing emails, verify that the sender's email address is valid and/or recognizable. Often, scammers use addresses with generic domains and random characters. But sometimes the difference is subtle, like with just one letter being off from a real ___domain name you trust.
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Wealthfront Investing
How to avoid crypto scams
Avoiding crypto scams isn't always easy, but some best practices include the following:
Do your research
Before buying any crypto, using an investing platform, or getting into an NFT project, be sure to do your due diligence. That can mean reading whitepapers, researching the project founders, and getting feedback from others in the crypto community.
Be wary of unsolicited offers
If someone reaches out to you out of the blue, especially if they promise high returns or say they're going to give you free crypto, that's a red flag, and you should often ignore these unsolicited messages.
Don't trust 'guaranteed' returns
All investment carries risk. Any crypto or DeFi project promising guaranteed returns or profits is likely a scam or at least misleading.
Secure your wallet
Do your research to find a reputable cryptocurrency wallet, and make sure you keep your private keys safe. That includes being very careful about who you share the keys with — generally, you shouldn't have to share with anyone, except in some rare occurrences like perhaps your spouse for estate planning purposes. Also, consider enabling two-factor authentication for added security for your wallet.
Verify website URLs
Phishing scams are often effective by imitating real websites, but perhaps the URL is slightly different. So, make sure you're on the right URL before entering private information, and be cautious about clicking any links via email or social media.
Be cautious on social media
In addition to being careful about links you click on, don't take everything you see on social media at face value. Plenty of unscrupulous individuals give fake or misleading investment advice or offer scam giveaways.
What to do if you've been scammed
If you've been scammed, it's not easy to remedy the situation, but there are still important steps you can take:
Report to authorities
If you come across a scam, you can report it to the Federal Trade Commission at ReportFraud.ftc.gov. Also consider reporting a scam to the FBI's Internet Crime Complaint Center (IC3), or your local law enforcement agency. Doing so can help prevent the scam from affecting others while also potentially helping you recover some funds or perhaps make the scammers face legal consequences for their actions.
Contact your exchange or wallet provider
Wherever you made the transaction that ended up being a scam, try reporting it to the exchange and/or your crypto wallet provider. This can similarly help prevent the scam from spreading and possibly lead to some recovery.
Seek legal advice
Depending on the size of the scam, consider consulting with a lawyer who specializes in cryptocurrency or financial fraud. They may be able to help you seek legal remediation.
FAQs about crypto scams
Can I recover my lost cryptocurrency?
There are services that offer support for recovering lost cryptocurrency, and it's possible actions like lawsuits and law enforcement could help. In general, though, there's no guarantee that you'll recover lost crypto.
How can I tell if a crypto project is legitimate?
Crypto fraud prevention isn't always easy, but you can get a better sense of whether a project is legitimate by researching the founders, reading the whitepaper of an ICO, and asking other investors or advisors you trust.
What are the red flags of a crypto scam?
A crypto scam, whether a Bitcoin scam, Ethereum scam, NFT scam, or anything else, often raises red flags with unrealistic promises, a lack of transparency, and urgency or hype that's used to pressure people into investing or taking action that reveals sensitive information.
