For most of the research that Chainalysis release in their annual Crypto Crime Report, the data tells “a clear story.”
For instance, funds sent to ransomware operators, darknet markets, or sanctioned entities can be measured and trends “can be analyzed with Chainalysis labeling and data.”
But blockchain data can also be “used to detect suspicious trading patterns. In these cases, the evidence on the blockchain is less definitive.”
Instead, on-chain data can “provide a starting point for deeper investigations, usually combined with other, off-chain information.”
For this reason, Chainalysis do “not include possible market manipulation proceeds or estimates of victim losses in our count of total illicit transaction volume — there isn’t enough information to determine whether the activity is criminal or not without additional context.”
Pump and dump schemes typically “involve an actor or group of actors investing in a token, heavily promoting that token to spur a price increase, and subsequently dumping their holdings at a significant profit.”
According to Chainalysis, this often results in “a heavy decline or even collapse of a token’s price, impacting unsuspecting holders.”
For this analysis, Chainalysis says they designed “a methodology to surface data points that identify potential areas for further investigation into possible market manipulation.”
They focused on DeFi, given its transparency and “the availability of on-chain information, which is not similarly available in centralized trading platforms.”
Specifically, they looked at “the Ethereum network, which has experienced rapid growth and innovation in recent years.”
Thanks to the ecosystem’s ERC-20 standard, or technical guidelines for Ethereum-based fungible tokens, it’s never “been easier to build new tokens on top of Ethereum, with all tokens able to be traded with one another and used on a variety of decentralized applications (dApps).”
Chainalysis uses on-chain analysis “to consider what some of these patterns look like, a critical tool for market operators and government agencies alike.”
Here’s how on-chain data could be used to identify elements of possible pump and dump schemes:
Between January and December 2023, just over 370,000 tokens “were launched on Ethereum, approximately 168,600 of which were available to trade on at least one decentralized exchange (DEX).”
As revealed in the update, the number of monthly tokens launched has “been increasing since mid-2022, with recent spikes in activity nearing 50,000 per month.”
This data comes from Transpose, the comprehensive source “for indexed real-time blockchain data.”
Not all of those tokens get significant traction, though.
In any given month, fewer than 14.1% of all tokens “launched achieve more than $300 of DEX liquidity within the subsequent month, and only 5.7% of tokens launched in 2023 are currently above that threshold.”
Although this is an increase from the previous two years, low liquidity values “suggest that the majority of tokens launched still cannot be easily exchanged with liquid assets such as ETH, wETH, USDC, USDT, and wBTC without having their prices significantly affected.”
There are many reasons that “could explain the failure to reach more liquid trading volumes.”
As the popularity of tokenization grows, launching new tokens into “an increasingly crowded marketplace becomes more challenging.”
However, some may be attempts at pump and dump schemes. Here is an example of how one type of token manipulation could occur:
An actor (or group of actors) either launches a new token or buys “a large share of supply for an existing token — usually one with historically low volume.”
This actor hypes up the token as an opportunity to “get rich quick,” typically using social media and online chat rooms like Discord and Telegram.
The persistent marketing on social media and chat rooms “attracts attention from users, leading to an increase in buying.”
The actor may also engage in wash trading, which “involves the simultaneous buying and selling of the same asset with the intent of falsifying its level of activity.”
If successful, the token rises in value.
Once the token reaches the desired price target, the actor “liquidates their position for a profit.”
The price of the token rapidly drops due to increased selling pressure, leaving many victims “holding the bag.”
If the actor is also the token creator, they may completely abandon the token project, taking more users’ funds with them, also known as a “rug pull.” However, this is “not always possible depending on the governance of the project.”
Many of these elements can be identified in on-chain data.