What is Rug Pull?
A rug pull is a form of crypto fraud that manifests itself when a project team artificially inflates the value of their token, only to suddenly withdraw funds, leaving investors with tokens that have no value. This process often involves the creation of a new crypto token by scammers, who then manipulate the market to inflate its price. Once they reach the desired price, they quickly withdraw the invested funds, causing the value of the token to drop rapidly, often to zero. Rug pull is particularly dangerous because it takes advantage of decentralized finance (DeFi), where traditional methods of verification and regulation are less present. Understanding the different forms of rug pull fraud is key to recognizing them and avoiding potential financial losses, so in today’s blog you will find out what all these forms of rug pull are and how to avoid them.
Source: cointelegraph
Types of rug pulls
In the world of cryptocurrencies, there are three basic types of rug pull scams that investors need to know to help protect themselves:
- Liquidity theft: this type of fraud occurs when token creators suddenly withdraw all funds from the liquidity pool, thereby eliminating all the value that investors have invested in the token. This results in the token’s price dropping to zero, often leaving investors with worthless digital assets. Liquidity theft is particularly common in decentralized finance (DeFi), where such manipulations are easier to perform due to the lack of centralized oversight, and often the anonymity of the creators.
- Limit sell orders: this method involves programming tokens in such a way that only creators can make a sale. After investors buy the token, developers wait for the price to rise and then sell their holdings, leaving investors with tokens that no longer have value. An example of such a scam is the case of Squid Token, where the developers took advantage of the hype around the popular TV series to lure investors before performing a rug pull.
- Dumping: this term refers to a situation where developers sell large amounts of tokens very quickly, leading to a drop in price. While buying and selling one’s own tokens is common, dumping becomes problematic when done over a short period of time, often after intense promotion, resulting in a pump-and-dump scheme.
Source: cointelegraph
Hard and soft rug pulls.
Rug pulls can be divided into two categories: hard and soft rug pulls. Hard rug pulls are those that involve directly manipulating the code of tokens or smart contracts to enable fraud. Examples include malicious backdoors in smart contracts, where developers plan fraud in advance and implement hidden exploits that allow them to withdraw funds without the investor’s knowledge. Liquidity theft, where token creators suddenly withdraw all funds from a liquidity pool, falls into this category. These types of rug pulls are usually clearly illegal because the intention of the project is obvious from the beginning. On the other hand, soft rug pulls refer to situations where developers quickly sell off their holdings in tokens, often after inflating them to high values. While this can be unethical, it’s not always clear if it’s a crime. Asset dumping can leave investors with devalued tokens, but without clear malicious intent or direct code manipulations, soft rug pulls sit in a gray area between unethical behavior and illegal activities.
Source: cointelegraph
Are rug pulls illegal?
Crypto rug pull scams represent a complex area when it comes to legality. While hard rug pulls are clearly illegal because they involve intentional malicious activities such as stealing liquidity and programming hidden exploits into smart contracts, soft rug pulls are in an unknown zone. They are unethical, but not necessarily illegal. For example, if a project promises donations and then keeps the funds raised, this is unethical, but it may not be illegal. The complexity of tracking and prosecuting such scams stems from the decentralized nature of the crypto industry. The case of the collapse of the Turkish crypto exchange Thodex, where $2 billion was stolen, stands out as one of the biggest rug pull incidents. Despite the fact that Turkish police have detained 62 people in connection with this case, the main suspect has still not been found. Other examples that illustrate this issue include protocols such as Meerkat Finance, AnubisDAO, Compounder Finance, and Uranium Finance, which have also been victims of rug pull scams. These cases show how rug pulls can have serious consequences for investors and require caution when investing in crypto projects.
Source: cointelegraph
How to avoid a rug pull?
There are several clear signs that investors can look out for to protect themselves from rug pull scams, such as unlocked liquidity and lack of external audit. The following are six signs that users should look out for to protect their assets from crypto rug pull scams:
Unknown or anonymous developers
Investors need to consider the credibility of the people behind new crypto projects. Are developers and promoters famous in the crypto community? What is their success so far? If the development team is public but not well known, are they still acting legitimately and able to deliver on their promises? Investors should be skeptical of new and easily faked social networks and profiles. The quality of the project’s whitepaper, website, and other social networks should provide clues about the overall legitimacy of the project. The anonymous developers of the project could be an indicator that it is a scam. Although it is true that the original and largest cryptocurrency in the world was developed by Satoshi Nakamoto, who still remains anonymous, but his code has always been publicly available and immutable.
Unlocked liquidity
One of the easiest ways to distinguish a scam cryptocurrency from a legitimate one is to check if the currency is locked in liquidity. Without a liquidity lock on the token supply, nothing is stopping the project’s creators from running away with all the liquidity. Liquidity is provided through time-locked smart contracts, ideally lasting three to five years. While developers can create time locks themselves, third parties that provide locks can provide more security. Investors should also check the percentage of the liquidity pool that is locked. A lock is only useful in proportion to the amount of liquidity pool it provides. Known as total value locked (TVL), this number should be between 80% and 100%.
Sales Restrictions
A scammer may code a token to limit the ability to sell to certain investors but not others. These sales restrictions are the hallmarks of a fraudulent project. Because sales restrictions are hidden in the code, it can be difficult to identify if there is fraudulent activity. One way to test this is to buy a small amount of a new token and then try to sell it right away. If there are problems selling what has just been purchased, the project is probably a scam.
Drastic price increase with a limited number of token holders
Sudden large fluctuations in the price of a new token should be viewed with caution. This, unfortunately, is true if the token does not have locked liquidity. Significant price spikes in new DeFi tokens are often “pump” signs before a “dump.” Investors skeptical of the token’s price movement can use the block explorer to check the number of token holders. A small number of owners makes the token susceptible to price manipulation. Signs from a small group of token holders can also mean that a few “whales” may sell their positions and cause serious and immediate damage to the token’s value.
Suspiciously high yields
If something sounds too good to be true, it probably is. If the yields for the new token seem suspiciously high, but it doesn’t turn out to be a rug pull, it’s probably a Ponzi scheme. When tokens offer an annual percentage return (APY) in the triple digits, even though this is not necessarily indicative of fraud, these high returns usually mean an equally high risk.
Lack of external audit
It is now common practice for new cryptocurrencies to go through a formal code audit process conducted by a reputable third party. One famous example is Tether (USDT), a centralized stablecoin whose team did not detect that it held non-fiat-backed assets. The audit is especially important for decentralized currencies, where a standard audit for DeFi projects is mandatory. However, potential investors should not simply take the word of the development teams that the audit has been done. The audit should be able to be verified by a third party and show that nothing malicious was found in the code.
Source: cointelegraph
Recognizing Crypto Rug Pull Scams
In 2021. An estimated $7.7 billion was stolen from investors in rug pull crypto scams. These investors believed they were investing in legitimate projects, but in the end, it turned out to be scams. Before investing, it is worth taking the time to research new cryptocurrencies and conduct a thorough analysis before investing in a new project, and only a detailed analysis can lead to a conclusion whether it is a scam or a legitimate project. Feel free to write to us on our social networks if you have ever encountered any rug pull, or any other crypto scam. Also, if you have any questions or suggestions, feel free to contact us (Twitter, Instagram).
