What is a Rug Pull & 6 Ways to Spot it

Introduction

With the mass adoption of the crypto space, the market has also attracted crypto scammers who wants to make some quick money. This huge interest for the investment in this volatile market is particularly prevalent in the crypto space as we embark upon a Web3 dominated ecosystem, where the steady stream of new projects is resulting in creating the buzz and also encouraging new investments from the participants. However, unlike the regulated traditional financial markets, the crypto ecosystem is still in its nascent stage, where the continuous increase in demand is being dealt with newer innovations. While that is happening, bad actors are keeping up with finding newer ways to trick unsuspecting investors and influence then to make some bad decisions. Some crypto scams are still using the traditional fraudulent techniques like Ponzi schemes, newer ways like rug pulls have become well known in Web3. As the rug pull scammers often opt for strategies that are new; like malicious smart contract code; many retail investors tend to get caught off-guard while developers flee with millions.

To understand what Rug Pull means, let’s dive in!

Additional Read: Biggest Crypto Scams in 2022, you must know in 2023

What is Rug Pull?

In one line, a rug pull is a crypto scam where the fraudsters lie to the public in order to attract funding and then quickly run off with the digital tokens of the investors. To explain it further, a rug pull is when project developers abruptly and knowingly shut down a startup once the target amount is secured along with the trust of the tokenized funds of their investors. So in simple terms, these pretenders just collect the money and flee, leaving behind only the worthless asset of their making.

One of the many reasons why it is absolutely imperative to do a thorough research and then jump into investing.

On a common note, a rug pull starts with the creation of a new crypto project that firstly gets listed on a decentralized exchange followed by getting paired with a coin from a leading platform, for example, coins like Ethereum. Once the pairing is done, the fraudsters then take advantage of the marketing powers of social media, to make the launch a buzz-worthy one. The builders engage themselves in hype-filled promotional campaigns across varied channels to bait a community of investors. 

These types of scams often carry with it empty promises of too-good-to-be-true yields or have a process to set the membership up for schemes which are similar to that of a Ponzi scheme. The main aim for the schemes is to gain enough traction, as it helps in increasing the platform’s value along with its token’s value. Once the price reaches a certain point, the core development team starts to dump its share of the tokens, thus making its way out with the treasury of investor funds.

Facts: Rug pull is a type of crypto scam which takes place when a team pumps the token of their project before vanishing with the funds and leaving the investors with a valueless asset. 

This emerging space of DeFi is prone to rug pull scams because of the lack of understanding that still prevails in the domain, the intermediaries involved in transactions and the potential for massive returns. The most important among all is the fact that many new crypto projects actually do start out in the same place, which makes these types of scams even more difficult to detect early on. While that is one of the cases, other times, rug pulls can be literally programmed into a project’s code by skilled developers, within a smart contract. To know more, let’s see what are the different types of rug pull that exists.

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Types of Rug Pulls

There are two main varieties that rug pulls come in; hard rug pulls and soft rug pulls. As evident from the name, a hard rug pull takes place suddenly, without any signs of warning. While on the other hand, a soft rug pull is when the token developers dump their crypto assets quickly after playing the long game. In doing so, they leave behind severely devalued tokens in the hands of the remaining crypto investors. However, the rug pulls can be categorized under three types. They are as mentioned below:

• Liquidity pool rug pulls: Liquidity pools are integral to many decentralized exchanges (DEXs) and crypto lending platforms. Anyone can contribute crypto to these smart contract-based pools to boost the total value locked (TVL) on a Web3 protocol. While crypto liquidity pools have many positive features, they’re a common tool used by crypto scammers. Developers who neglect to include transparent locking mechanisms in their code can transfer the protocol’s funds into their wallets and abandon the project.
• Limiting Sell Orders: A more clever tactic for rug pulls involves blocking or limiting a users’ ability to sell coins on a trading platform. These are tactics that can be manipulated at any point in time. Once an exchange has gathered a substantial amount of traffic, backend fraudsters may amend a project’s code to only grant traders the ability to buy into a platform. Rug pull tactics that specifically manipulate smart contract technology to funnel money one way are virtual traps known as honeypots. The end goal of a rug pull will always be to cap at the highest amount possible. 
• Dumping: The last type of a rug pull is known as dumping, which takes place when developers quickly sell off their own large supply of tokens. In doing so, they drive down the price of the coin and leave the remaining investors with worthless tokens. The process of “Dumping” usually takes place after a heavy promotion on various social media platforms. This tends to result in a spike, known as Pump, and a sell-off is known as dump, together this method is commonly known as a Pump-and-Dump Scheme.

Did You Know? Dumping is more of an ethical gray area than other DeFi rug pull scams.

How to Spot or Avoid A Rug Pull

Rug pulls are quite hard to spot if one is not aware of what to look at in the first place. However, there are a few red flags that the investors should look out for while evaluating new tokens: 

• Token Whitepapers: A proper crypto project should have a clear roadmap for its project. One of the other important things is for them to have a list of all the achievable goals and strategies in a detailed whitepaper. A whitepaper that is vague or if it is littered with grammatical errors, there is a good chance that it is a scam project. 
• Devoid of an External Audit: Investors can have a higher degree of confidence in a dApp’s code if there has been a formal review from a legitimate auditing firm. 
• Anonymous Developers: This makes the project questionable as if a new crypto project’s developers are fully shadowed, authorities cannot hold them accountable, to make the rug pull identification easy. 
• Massive Social Media Marketing: If it feels like a new project is being excessively spammy online, it may be a warning sign something’s up. 
• Suspicious Price Behavior: If you notice sudden changes in a token’s price history or trading volume, it may signal market manipulators are pulling the strings. Always be wary of sudden price surges that aren’t backed by noteworthy news on the crypto project.
• An Established Team: Verifying that the team behind the project is actively engaged with its platform’s community, gives an assurance about the authenticity of the project. This should include consistent updates sharing the project’s progress in a transparent manner. Results should reflect a trajectory as outlined in its white paper.

Read More: Top Crypto Projects in 2023

Successful rug pulls in history

Some of the notable rug pulls in history are as mentioned below:

• The SQUID Token Rug pull that took place after the massive Netflix hit show, Squid Game.
• OneCoin, the Bulgaria-based company, where the developer managed to dupe the members out of $4 billion from 2014 to 2016.
• The Africrypt incident, which was a $3.6 billion attack that took down South African crypto investment platform in 2021.
• PlusTolen, where the creator Bo Chen and his team said to have siphoned $2.25 billion from South Korean and Chinese investors.

Conclusion

Crypto space is still in its development stage and schemes like rug pulls are able to exist because of the lack of thorough knowledge about the space. In today’s scenario, rug pulls still account for billions in losses a year. However, these crypto scams can be so smooth that they can make it difficult to distinguish between a legitimate Web3 start-ups from a rug pull. To avoid such scenarios, taking educated guess is the most important step.

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