After the pump signal is given, group members flood the chosen exchange, first buying up the token, then promoting it on social media and messaging apps. The initial buy orders cause the token’s price to surge (its first wave), while the media hype creates its second wave — speculators who buy in at the inflated price, believing that the price rise is based on real demand. Group members are instructed to sell the token once it reaches the target price, yet the price usually crashes before then due to panic and misinformation, causing both the speculators and often times participants in the pump to lose money.

Beyond the damage to uninformed and misinformed buyers, pump and dumps cause real problems for token creators, as price volatility erodes confidence in potentially legitimate tokens as well as in the broader token economy itself. Small-cap tokens in particular are common targets because their relatively low trading volume makes them more susceptible to acute price swings. This threatens tokens in their earliest stages of growth, when community trust and cohesion are critical.

Recently the same pump and dump group mentioned earlier took aim at BNT, the network token that allows Bancor to provide continuous and instant conversion between Smart Tokens™ in the Bancor Network. The pump failed to reach its target price and the reaction of BNT to the attempt demonstrates how Bancor uses smart contracts and arbitrage to create a price anchor that protects tokens against artificial spikes.

Here’s how the price anchor works: As the price of BNT rises on an external exchange in response to a pump, a discount emerges between the BNT price on the exchange and the calculated price of BNT on the Bancor Network. This discount incentivizes arbitrageurs (who are, in many cases, bots) to buy BNT on Bancor and sell it on the external exchange for an immediate profit. These sales apply downward pressure on BNT’s price on the exchange until there is price consensus between Bancor and the exchange. This effectively chokes the attempted pump on the external exchange as a sell wall stabilizes the token long before it reaches its target price.

The attempt to pump BNT missed its target price by over 30%, prompting the group’s organizers to send an apology to members: “Today’s pump was not what we hoped it would be. We suspect there was another wave of bots involved. We’ve also noticed an increased amount of sell walls on low volume coins.”

Because the pump created only a small spike in BNT’s price, the potential for profits was slim and far less damage could be inflicted on would-be token buyers.

Comparing the price of BNT to the price of other tokens during known pump and dumps shows BNT’s relative resilience to price manipulation.

Combatting pump and dumps with automated arbitrage requires a smart contract that is always available to buy and sell the token at predictable rates, continuously calculated and displayed. This reduces risk for would-be arbitrageurs who can now easily collect even small amounts of profit and do so consistently, limiting the ability of a pump to gain momentum.

The bid/ask model employed by most exchanges isn’t as effective at preventing volatility during pumps because liquidity isn’t as accessible or predictable for arbitrageurs. Take, for example, an exchange with no liquidity because sellers believe the price rise in the pumped exchange is indicative of real demand and therefore refuse to sell at a lower price. A Smart Token does not make these considerations. It will always be available for purchase and will only increase its price based on actual purchase volume, so it can be relied on to provide a low-risk, predictable, transparent buy or sell opportunity which facilitates immediate arbitrage.

Finally, it can be difficult to create arbitrage between exchanges if accounts are needed on both sides with sufficient deposit and withdrawal limits. Smart Tokens, purchased directly from their contracts on-chain, have no limits and require no registration, making them significantly more accessible to arbitrageurs and, in turn, more effective in the fight against volatility.

The ability of a Smart Token to counter artificial price swings is not only limited to BNT, but available to all tokens in the Bancor Network. In theory, if every asset adopted this new model, giving buyers access to continuous and frictionless liquidity at predictable and transparent prices, based on real purchase volume — pump and dumps would effectively disappear. Stability would permeate throughout our asset exchange ecosystems and allow for a wave of innovation to be unleashed.