What is a rug pull in crypto?
A rug pull is a crypto scam where developers lure investors, but pull out funds before the project is completed. This leaves investors with worthless assets.
Rug pulls occur when fraudulent developers create new crypto tokens, increase their prices and then extract as much value as they can before selling them off as soon as their price drops to zero. Rug pulls can be used as a way to exploit decentralized finance (DeFi), and are a form of exit scam.
It is important to understand the differences between types of rug pulls in crypto.
Three main types of crypto rug pull
When token creators take all of the coins out of the liquidity pool, it is called liquidity stealing. This removes all value that investors have injected into the currency, driving down its price to zero.
These “liquidity stealing” are most common in DeFi environments.
Limiting sell orders
A malicious developer can deceive investors by restricting sell orders. The developer codes the tokens to ensure that only they can sell them.
The developers then wait for retail investors who will buy their crypto using paired currencies. Paired currencies refer to two currencies that have been paired in order to trade, one against the other. They dump their positions when there is sufficient positive price action and leave behind a useless token. example: Squid Token scam
Developers sell their tokens quickly to get rid of excess stock. This lowers the price of the token and leaves investors with worthless tokens. “Dumping” is usually triggered by a lot of promotion via social media platforms. A Pump-and-Dump Scheme is a term for the resulting spike or sell-off.
Dumping is more ethically gray than other DeFi rug-pulling scams. It is ethical for cryptocurrency developers to purchase and sell their own currencies. DeFi cryptocurrency rug pulls are characterized by “dumping” which refers to the amount and speed at which a coin is sold.
Soft pulls and hard pulls
Rug pulling can be either “hard” or “soft”. When project developers embed malicious backdoors in their tokens, hard rug pulls can occur. It is obvious that the developers intend to commit fraud right from the beginning. A hard pull is also liquidity stealing.
Soft rug pulls are when token developers pump and then dump their crypto assets quickly. This leaves tokens that are severely devalued in the hands of remaining crypto investors. Dumping is unethical but it might not be as criminal as hard pulls.
Are crypto rug pulls illegal?
Although not illegal in all cases, crypto rug pulling is always unethical.
Hard rug pulling is illegal. If a crypto project promises funds but decides to keep the money, it is unethical, but not illegal. Both types of fraud, as with most other fraudulent activities in crypto, can be difficult to track down and prosecute.
How to avoid a crypto rug pull?
Investors should be aware of several indicators that could indicate that they are at risks of being ripped off, such as liquidity not being locked or an external audit not having been performed.
These are six indicators users need to be aware of in order to protect their assets against crypto rug pulls.
Developers not known or anonymous
Investors need to consider the credibility and reliability of those behind crypto projects. Is the crypto community well-known? What is their track record? Is it possible for the development team to be doxxed, but not well-known? Do they still seem legitimate and capable of delivering on their promises?
Investors should be cautious about investing in fake social media profiles and accounts. You should look at the quality of the white paper and website as indicators of the legitimacy of the project.
An anonymous project developer could be a red flag. Although Satoshi Nakamoto is still anonymous, it is true that the largest and most original cryptocurrency in the world was created by him. However, times are changing.
There is no liquidity lock
Checking if the currency has liquidity locked is one of the best ways to tell the difference between a scam coin and a legitimate cryptocurrency. The project creators can run off with all the liquidity if there is no liquidity lock on the token supply.
Time-locked smart contracts provide liquidity, which can last three to five years after the token’s initial sale. Developers have the ability to create their own time locks but third-party lockers provide greater security.
Investors should also verify the percentage of the liquidity pool that is locked. The liquidity pool that the lock secures is what will make it useful. This is known as the total value locked (TVL). It should be between 80%-100%.
Limits on sales orders
Bad actors can program a token to limit the selling power of investors. These restrictions on selling are a sign of a scam project.
It can be difficult to determine if there has been fraud because selling restrictions are embedded in the code. This can be tested by purchasing a small amount of the new cryptocurrency and then trying to sell it. The project could be fraudulent if it is difficult to offload the coins you have just bought.
Skyrocketing prices with token holders
You should be cautious about sudden and large swings in the price of a new coin. If the token is not liquidity locked, this can be very dangerous. Substantial price increases in DeFi coins are usually a sign of the “pump”, before the “dump.”
To check the number and validity of a coin’s holders, investors can use a block-explorer. The token is more vulnerable to price manipulation if there are only a few holders. A small number of token holders could indicate that some whales are able to dump their positions and cause severe and immediate damage.
High yields are a sign of trouble
It’s possible that something is too good to be true if it sounds too good to me. If the yields on a new coin look suspiciously high, but it turns out not to be a rug puller, it’s most likely a Ponzi scheme.
Tokens that offer a triple-digit annual percentage yield (APY), are not always a sign of swindling. However, high returns can often translate into high risk.
No external audit
New cryptocurrencies must now undergo a formal code audit by a trusted third party. Tether (USDT) is a well-known example of a centralized stablecoin that failed to disclose it had non-fiat-backed assets. Decentralized currencies are a good example of a need for auditing. DeFi projects require default auditing.
Potential investors should not rely on the word of a development team to verify that an audit was conducted. An independent third party should verify that the audit was conducted and prove that there were no malicious code errors.
You need to do some digging in order to spot a scam involving crypto rug pulling.
Investors in rug pull crypto-scams were robbed of $7.8 billion by 2021. Investors believed they were investing in legitimate projects. But the rug was pulled under their feet.
It’s worthwhile to take the time to research cryptos before you invest in any new projects. Please Keep these words in mind: no trust, but verify.