The Web3 Rabbit hole

What is a Rug Pull?

Naga Pramod
Naga Pramod

It was the second day of November 2021 when the world of cryptocurrency witnessed an explosive jolt. Was it something new? No, not really. But it did come as an earth-shattering experience for investors who had invested their hard-earned money in a cryptocurrency token, SQUID ($SQUID).

Launched as a meme coin just a week back on October 26, SQUID was inspired by the popular Netflix show, Squid Game. The token skyrocketed by 23,000,000% in a week to peak at around $2,862. However, what followed was something that nobody imagined. Within a matter of minutes, the price value fell to a fraction of a cent.

This phenomenon is popularly known as “rug pull” in cryptocurrency. There’s a lot more to it that we will discuss in this article. Let’s get started.

What exactly is a rug pull?

A rug pull is a popular cryptocurrency scam that tricks people into investing in shady assets. It is when project owners make lofty promises, and it turns out to be something else entirely.

In the world of cryptocurrency, many people get tricked into thinking they are buying an asset that will be worth a lot more in the future. They purchase these assets only to find out later that the owners had malevolent intent to rob them of their money.

Rug pulls are usual across the decentralized finance (DeFi) ecosystem. Malicious project owners often create a token and list it on a decentralized exchange (DEX) by pairing it with a cryptocurrency like Ethereum (ETH).

Once there is enough interest among unsuspecting investors, the token’s price shoots up significantly. At that point itself, owners empty the liquidity pool that drives the price close to almost zero.

The different types of rug pull

Let’s look at the different types of rug pull with suitable examples.

·       Liquidity theft

Liquidity thefts commonly happen in the cryptocurrency space when project owners completely withdraw assets from the liquidity pool that funds the project. The value of the cryptocurrency declines rapidly to almost nothing as soon as the liquidity theft happens. What is left with investors is a worthless asset with no practical use. Crypto owners lost almost $2.8 billion in such rug pull scams in 2021.

·       Sell order manipulations

It is a more sophisticated scam adopted by manipulative project owners. They code the cryptocurrency with a smart contract that makes them the only one with the authority to sell the coin. There’s no way you can sell such cryptocurrencies or coins even after paying your money to buy them.

Such investors get fooled by holding an asset that remains unsellable and of no real worth. Project owners often lure naïve people into buying these cryptocurrencies by creating hype around the project. They use social media platforms such as Twitter and Telegram to attract investors to their projects.

·       Pump and dump

We often see a cryptocurrency shooting up its value by almost 30-40% within minutes. However, the subsequent few hours witness a downturn where the price starts declining rapidly to touch daily or weekly lows. This Ponzi scheme is nothing but pump and dump.

Fraudulent project owners lure people to invest in their cryptocurrency through enough publicity measures. When there is enough interest and the price shoots up, they sell a major portion of the cryptocurrency. It leads to project owners profiting from investor money, leaving them high and dry.

Different forms of rug pull

A rug pull can be hard or soft, depending on the malicious intent of the project owner. Hard pulls happen when owners code the cryptocurrency with smart contracts or steal the liquidity that funds the project.

Not every project developer in the crypto space is compelled to have  clear intentions, making it indispensable for investors to do thorough research on a project and the dev team behind it before putting down their money. Developers can often turn the table in their favor by trapping inexperienced investors and vanishing with their money.

Soft rug pulls are common, and you may witness them almost daily if you trade actively. It involves the dumping of an asset, which leads to a decline in value. However, it is essential to note that dumping doesn’t necessarily mean a criminal act. It may remain unethical, and perhaps illegitimate, though.

Rug pulls Across DeFi and NFT projects

As we have already seen, rug pulls are fairly common across DeFi projects. The same is, unfortunately, true with NFTs too. A major rug pull in the NFT space happened in January 2022 with the Frosties project. The project had around 8,888 NFTs that became zero overnight.

The overall project size was almost $1.3 million. Frosties’ project owners were quite active on social media, sharing updates about the project. It drew the interest of investors who began putting in their money. Eventually, on January 10, their Discord channel, website, and Twitter account disappeared. Creators withdrew the investors’ fund and left the project with around $4,000 worth of ETH.

Rug pulls are common across DEXs as they allow free and audit-less listing of tokens. It is also easy to create open-source tokens on the Ethereum platform for free. These are the prime starting points for malicious project owners who want to siphon off people’s money.

5 ways to spot a rug pull and avoid it

Here’s how you can spot a rug pull and take suitable measures to avoid getting trapped.

·       Lack of developer credibility

The most important thing to do is look for independent reviews from experts in the field. You can also search for information about past developer projects and see if they have any complaints or negative reviews.

Another good way to check the developer's reputation is by looking at their social media profiles. You can start with LinkedIn or Twitter as they are more professional than Facebook or Instagram pages. If you find any questionable behavior, it could indicate that they may not be trustworthy or reliable enough for you to invest your hard-earned money.

·       Liquidity locks

One of the easiest ways to avoid a rug pull scam is to check whether a cryptocurrency has its liquidity locked. If there’s no liquidity lock mechanism, the project owner could vanish anytime with the money. A good cryptocurrency project will often have secure liquidity that lasts for up to five years since its initial listing.

The chances of project owners creating their script to edit the time lock remain high. However, third-party liquidity locks help in this case. You should also check for the amount of liquidity locked in the pool. It should ideally be around 80-100% of the total value.

·       Irrational price fluctuations

Some cryptocurrency projects may have limited token holders yet could witness massive price fluctuations. If there’s a new project with extreme volatility, you should always proceed with caution. It is especially critical to consider whether or not the project has its liquidity locked.

Projects with substantial fluctuations are often associated with the pump and dump concept. You may want to invest when the price is skyrocketing. Within a few hours itself, however, the price may come down drastically, leaving you with almost nothing in hand.

·       Extreme yields

Cryptocurrencies need careful consideration of all aspects before you invest your money. You may often come across projects that offer returns of up to even three digits in no time. If something sounds too good to be true, it often is.

Such project owners usually try to lure people through social media platforms Twitter, Telegram, Discord, and others. Keep in mind to research the project’s facts and check for reviews online. If you find anything suspicious, it is your cue to steer clear of the project.

·       Selling limitations

Limitations on selling cryptocurrency are a hallmark of most leading fraudulent projects. Project owners can code the cryptocurrency to not allow anyone else except them to sell it. There are limited measures to test this scam, though. You may not even realize it unless you are a part of it.

One of the options, however, is to buy a meager amount and sell it instantly. If you are unable to sell it for any reason whatsoever, there are good chances it is a scam project.

Conclusion

Rug pulls are common in the cryptocurrency space. A rug pull scam can happen anytime, leaving you high and dry. The lesson, then, is to be very careful when making your investment. It is best to be even more cautious with the amount of money you put into this investment. And this applies to every cryptocurrency project, irrespective of its type.

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