I got this hilarious— and NSFW, as the kids say these days— question on my podcast. Here it is:
Hey Nicole! I’ve been hearing the phrase “pump and dump” a lot around crypto. Like, I saw a little while back that Kim Kardashian and Floyd Mayweather were getting sued for a pump and dump scheme. It sounds like something your mom would say during a sex talk, like “boys only want one thing…. he just wants to pump and dump.” But I’m fairly sure that’s not what this means in the finance world… so what does it actually mean? Money move? Or frat boy strategy?
It’s a Money Move.
Pump and dump is definitely a phrase that you’ll see a lot in the financial trades, but it’s actually not a phrase exclusively reserved for crypto. It’s a term that is also used within the stock market, and it goes back to the origins of the stock market itself.
So this is a great opportunity for me to nerd out and take you on a little historical tour of the most important financial system in our world— the stock market.
When I say “The Stock Market,” what do you picture? Maybe you think of a green “Wall St” street sign. Maybe you think of a serious-looking building with big, imposing marble columns. Maybe you think of Leo in a cocaine frenzy in The Wolf of Wall St. But what is the stock market, actually?
Now, For Some Time Travel.
If you’re thinking of the stock market as a physical location, you’re not actually thinking of the stock market at all, you’re thinking about a stock exchange. Not to go all hippie-dippie on you, but the stock market is more of a system than a physical location. The stock market is what has been born of the semi-modern idea that you can give money to someone who needs it now, with the hope that the money will come back to you—and then some— in the future.
I say semi-modern because while the dinosaurs weren’t investing in start-ups way back when, there is still a rich history to the stock market. Long before there was a Wolf of Wall St, even before there was a Wall St, there was the Dutch East India Company. If you’re a finance nerd like me, or if you’ve seen your fair share of pirate flicks, you’re probably a little familiar with this type of biz. The Dutch East India Company was revolutionary in its time, which, by the way, was the 1600s.
Not all historians agree (shocker), but most pinpoint the start of the investment system as we know it to the 1600s, when European countries were sending explorers all over the world to fetch spices, tea, and all sorts of goodies to sell.
But, remember, this is the 1600s; there were no “more legroom” seats on boujee airlines just yet. All journeys were by sea, and they were perilous. To make one of these epic expeditions across oceans, you needed a ship-shape crew, food, tools, rum, water, more rum, and so on. Oftentimes these trips would last months. All of these expenses added up, but the potential payout of these trips were massive. So, sailors would go around, asking wealthy merchants to front them the money for the journey. In exchange, when the sailors came back with the goods, they would split the profit with their sugar daddies. These transactions lay the groundwork for the modern-day investment structure.
The Dutch East India Company was an entity in this game. Plus, the Dutch East India Company also happens to be considered the very first publicly-traded company. Yes, public companies are THAT old. Can you believe that financial experts have had 400 years to come up with a good explanation for public companies and most of the time, they still suck at it? Ugh.
A company is considered to be “publicly traded” if it sells pieces of ownership in the company (and the promise of some future perk) to the public. That’s it! It’s really not that complicated.
The Dutch East India Company is the first company on record to do this. At the time, this brand-new structure gave wealthy merchants better financial opportunities than ever before. Put yourself in the (probably uncomfortable) shoes of a 1600s investor. The best option before The Dutch East India Company went public was to invest in one sailor’s journey. That was a pretty risky move. If the ship sank, your investment went to the bottom of the ocean alongside it. But this new opportunity? Now this was something special. The promise of a payout after a successful journey was still there; but with the Dutch East India Company, instead of investing in one journey, merchants would be giving their money to a company that executed many journeys; instead of investing in one ship, merchants could now invest in a whole fleet. So if one ship went down? No problem. Their money would fund the next one. And voila! Modern-day investing was born.
Here’s How You Made $$$
If you bought shares in the Dutch East India Company, you could make money in two ways. 1) You could have an agreement with the company to get a portion of the company’s profits, called dividends. Or, 2) you could sell your shares to another interested investor and pocket the money from that sale. This second money-making method gave rise to the first stockbrokers, or, more generally, shareholders who sell shares to other investors.
In the 1600s, the approach to selling stocks was an “anything goes” system… and, yes, this is where the “pump and dump” phrasing comes in. These early stockbrokers would try to jack up the price of a stock by creating elaborate lies about the company. It would essentially go like this: a broker would go up to a wealthy merchant and say something along the lines of: “Hey dude, I hear that there’s a Dutch East India Company ship filled with gold, treasure, love potions, and spices that make you taller. It’s going to be coming back to port literally any day now. Dividends are going to be massive for all investors, bro. I need cash right now because my mom is sick, so I’m going to have to sell my shares… but shareholders are going to make some serious dough in the next few days, so you should totally buy me out. I’ll give you a good deal.” Then, obviously, the merchant would buy the share at whatever price the broker named (because who doesn’t want to be tall and popular?), and the stockbroker would pocket that cash. Then, when the Dutch East India Company ships would come back sans gold and love potions, the merchant would realize that the price of the share actually wasn’t quite worth what they paid. And that— ladies and gentlemen— is what it means to pump and dump. It’s when someone owns an investment security— like shares of a stock, or cryptocurrency— and they try to inflate the value of the asset through phony tactics so that they can sell the asset at an inflated value, and pocket the profit before people realize that they bought into an investment at a higher value that it’s worth.
Pumping the Brakes on Pump and Dump
This pumping and dumping was happening a lot in the 1600s and it actually only got worse in the next century. In the 1700s, merchants would get together on Wall Street and sell shares auction-style— and, yes, that is the very same Wall Street that exists in modern-day New York. At that time, men (that’s not a typo, it was exclusively men at the time), would stand on Wall St. and shout out the prices that certain shares were selling for. Interested investors would gather around Wall Street and bid on these stocks, and shares would go to the highest bidder.
This system changed forever when in 1792, a couple of stockbrokers got together and signed the Buttonwood Agreement. These stockbrokers were fed-up with this system of auctioning off shares. They had their experiences with phoneys coming in and pumping and dumping— which, was annoying if you fell victim to a pump and dump scheme, but the even bigger deal was that some Americans were becoming skeptical about the whole investing system altogether because of the prevalence of pump and dump schemes. Even just the suggestion of how the rumor mill and gossip affected share prices made investors skittish.
In order to block out the noise from sketchy sources and garner the public’s faith in the system, these stockbrokers decided that they would only trade between themselves behind closed doors. Make no mistake, this move wasn’t motivated entirely by the goodness of their hearts. By trading behind closed doors, these stockbrokers also shut out any other stockbrokers who wanted “in” on what the Buttonwood boys had. Plus, they cut out the independent investors who had been taking the DIY approach and investing their money themselves; before the Buttonwood agreement, anyone could stroll down to Wall Street and buy shares through the auction system. After the Buttonwood agreement, if you wanted to invest, you needed to place your money (and your trust) in the stockbrokers hands.
Moving stock trading from the streets of New York inside four walls redefined investing as a private system that takes place in a centralized location. This space the Buttonwood boys chose became known as the New York Stock Exchange (NYSE) and it is still the most iconic exchange in the world. The NYSE is so legendary, that oftentimes when someone says “the stock exchange,” they’re likely referring to the NYSE, even though there are many stock exchanges all over the world. Essentially, a stock exchange is a space where stocks can be sold and purchased, legitimately. And we’re right back to the definition of the stock exchange, and the beginning of the article. Full circle.
xo,
