Cryptocurrencies and decentralised finance (Defi) have become some of the most revolutionary financial inventions in recent history. Defi allows access to financial services without the constraints that come with dealing with centralised financial institutions like banks. The growth of DeFi has been tremendous with its total market cap hitting more than $146.11 billion.
While Defi growth is great for financial access, the sector also provides the best avenue for theft and other criminal activities. Rug pull is one of the most prevalent crimes in the DeFi world. Here is all you need to know about rug pulls and how to keep safe.
What is a rug pull?
Crypto rug pull is a theft where the owner of a crypto project abandons it after stealing investors’ money. They tend to be low-effort projects created by a few individuals with the goal of fleecing unsuspecting investors. It is most commonly mentioned when a token’s team removes liquidity.
The crypto world is susceptible to rug pulls due to loose regulations surrounding its operations. Unlike traditional companies with strict government control, the decentralised nature of crypto projects means the full control is left with private entities. This makes it open for exploitation by scammers, ransomware issuers, hackers, attackers and more.
Most of the time, rug pulls start as any other genuine crypto project. They can seem to be performing so well with massive value increases. This attracts genuine investors, only for the project to disappear after some time.
Types of rug pull
Here are the different types of rug pulls and how they happen.
Stealing liquidity is the most common type of rug pull. It involves a fraud project developer listing an altcoin on a decentralised exchange (DEX), and pairing it with a top performing cryptocurrency like Ethereum (ETH). To make the created project tradable, the developer must create a liquidity pool which holds a certain amount of the currency.
The developer will then create a hype around the new project and attract investors to it. As more investors take up the token it starts rising in value, this will attract other investors who believe it is a viable opportunity. By this time, the investors will be exchanging their ETH with the new project at the liquidity pool.
Once the token becomes valuable, at a time of their choosing, the malicious developer will withdraw all the ETH from the liquidity pool. Investors in the pool will remain with no way to trade back their now worthless tokens if the investor cashes out the legit ETH from an exchange.
The other type of rug pull involves the developer of a crypto project disabling the ability to sell the tokens. In this scam, the developer exploits the “approve” function of the ERC-20 tokens. With the manipulation, the buyer would not be able to spend their tokens once purchased.
At the time of purchasing the token, an investor would think they can freely buy, sell, convert or spend their token in any way they wish. Only to later find out the spending abilities are limited to the developer or whom they choose as per the contract.
Once the token’s value grows high enough, the malicious developer sells all the tokens, making away with all the invested funds.
Developers cashing out
From the free market outlook, this does not look like a rug pull. However, given that it involves a token created for the sole purpose of fleecing investors, it does qualify to be one.
In this case, the developer shows the prospective investors a token feature or platform in development and that will soon be released. In reality, it’s a worthless token with no real purpose.
The developer gives themselves a bigger portion of the project. With the promise of good things to come, the investors put their money in the project increasing its value. The developer then cashes out their share either once or gradually, while the investors remain with the worthless tokens.
Examples of rug pulls
Here are some recent examples of rug pulls;
Squid game rug pull is the latest and one of the biggest rug pulls in crypto history. Squid token was a play-to-earn token inspired by the Netflix hit TV series Squid Game.
The token experienced tremendous growth in the earlier weeks after launch, rising by more than 33,600% from a cent to hit $3.36.
The massive growth of the token ultimately hit $2861, before it suddenly vanished. Someone had dismantled the Squid token while it’s promoters became unreachable. By this time, more than 43,000 investors had put their money in the token.
The coin is currently worth $0.003028. At the same time, investors have also realized they cannot sell their tokens. The project developers had imposed an anti-dumping mechanism which meant no one could sell the tokens from Uniswap’s decentralised exchange. There is no hope that the investors will ever recover their money.
Luna Yield was an ecological liquidity farming project running on the Solana (SOL) platform. The SOL project has been growing steadily, surpassing $2 billion in total locked value (TVL) before Luna Yield disappeared. The project’s developers suddenly deleted their website, Telegram and Twitter accounts and withdrew almost $10 million in liquidity.
Following the deletion of the social media accounts, the Luna Yield investors tried to unsuccessfully withdraw their unstaked funds, due to there being zero balance in the pool. On further investigations, the Luna Yield community established that the address of the developer of the project had approved the transactions leading to the rug pull.
OneCoin is one of the biggest Ponzi schemes ever in the crypto market. The developers of the project were able to get away with more than $4 billion from unsuspecting investors. Some of the leaders of the project were later arrested, while others disappeared while the project continued. To make it worse, OneCoin was never traded, neither could it be used to buy anything as it had no blockchain model or payment system.
As the crypto market expands, so does the risk of theft and scams. In 2021, over 1300 exit scams were pulled.
Common signs of a rug pull
Some of the common indications for a rug pull include;
The developers of a project are crucial when it comes to a crypto project. Even though the most successful crypto, Bitcoin, was created by an anonymous Satoshi Nakamoto, most altcoins have well known developers behind them.
Developers who prefer hiding behind pseudonyms might be planning to evade legal follow-ups once they have fleeced investors. Avoid such projects as much as you can.
The project appeared overnight
Crypto projects take time to develop and grow. However, with rug pulls they tend to come out of nowhere. They mostly use memes, culture and trends to reach a wide audience. For example, Squid token was inspired by the TV series hit, Squid Game. The developers understand investors were more likely to jump on hot trends.
These projects also tend to be accompanied with a lot of hype and promises that seem too good to be true.
The liquidity of a project is the determinant of how fast you can convert it into cash. A low liquidity should be a red flag when it comes to investing in a project. At the same time, you also need to look for liquidity lockups. The lockup sets aside a certain amount of token at any given time needed for the pool to operate. It helps ensure the developers cannot empty the platform at once and get away with it.
Extensive marketing tactics
For a legit crypto project, its main selling point should be the use cases and the challenges it seeks to tackle. However, given that most rug pulls do not have any real use case or solution, they resort to aggressive marketing. They rely on social media posts, influencers and paid advertisements to reach as many people as possible.
Overnight value skyrocketing
The world operates like any other business whose values grow based on demand and supply. A legit project will have an explainable growth process. Therefore, in case a project grows in value out of nowhere, there is a likelihood of some few traders trying to use the FOMO tactic to lure investors.
How to avoid a rug pull
Losing money in an investment project is not easy to process. You therefore have to protect yourself from falling for rug pulls. Once you have mastered the signs of a rug pull, it is a little easier to detect one before falling victim.
You only have to check for the signs before investing in a project. Scrutinise the project by first understanding what it is all about. Look into the developers, liquidity, its holders and listings on DEX platforms and reviews, whitepaper and social media.
The growth of the Defi and other crypto projects have led to convenient access to financial services. However, it also comes with the possibility of losing money through rug pulls. Therefore, do your due diligence before investing in any crypto project. Also, only invest what you are willing to lose.