What is a rug pull?
Updated: Nov 8
As is known, the world of cryptocurrencies, especially DeFi, is not risk-free. If you are inexperienced or careless, you can encounter malicious projects and scams. These frauds are known as rug pulls. But how do these rug pulls work, and how can they be identified and avoided? Let’s find out together!
The term rug pull comes from the combination of pull and rug and describes the skilful movement of pulling the carpet while there is over a person. This image perfectly explains this phenomenon of trust followed by disappointment. In the cryptocurrency industry, the term rug pull is meant a full-fledged scam, where some developers create a project to collect money and then abandon it and run away with investor funds. Unfortunately, this is a common scenario in DEXs, where a multitude of tokens are listed for free, unlike what happens in CEXs. There are more and more third-category tokens listed and paired with a cryptocurrency among the most capitalized, such as Ethereum (ETH).
How does a crypto rug pull work?
Let’s take a practical example to understand its functioning!
A million tokens worth $0.01 each are created, 200,000 of these tokens are distributed to followers on Social channels, while the creator holds the other 800,000. As a result of distribution transactions and exchanges between the community, the token gets the value of a dollar. At that point, the creator sells all his tokens and pockets around $800,000, dropping the token value due to the huge exchange volume. All token users end up with an asset that has lost almost 100% of its initial value.
In short, these scammers aim to promise a project with a specific mission, wait for the uproar around the project, and distribute the tokens withholding the majority. As the majority shareholder, the scammer will then decide to sell his tokens when the value goes up without communicating it to the community. By doing so, it has lost value to tokens held by other users.
Find out the difference between soft and hard rug pulls.
Examples of rug pull
The increasing creation of new projects and the large number of users driven by the thirst to get rich quickly are favourable factors for the spread of rug pulls.
Below is a list of recent period rug pull cases:
Defi 100 coin
A deep dive into the biggest crypto rug pulls!
How to protect yourself?
A Rug Pull is very common in the crypto context; it is a type of scam that can be identified, and therefore, it is good practice to follow some rules to learn about and avoid them.
First of all, you have to read the project documentation.
Due diligence can help you understand products, starting with the whitepaper and roadmap.
Liquidity is another important signal whose low quantity or lack of a blocked reserve could be interpreted as a potential red flag. The first could mean the impossibility of withdrawing, and the second because it makes the Rug Pull viable since there are no constraints to the liquid pool.
The sudden increase in prices is also not a good sign. It often coincides with price manipulation, and in this case, it is important to keep the FOMO (Fear Of Missing Out) at bay and always proceed with a rational approach.
Summarizing them in a list, these are the signs that should put us on alert:
Creators remain anonymous;
Coin prices skyrocket;
Yields are too high;
No liquidity lockup:
Extensive marketing tactics.
In conclusion, the best practice to detect and avoid a rug pull are:
Confirm team credibility;
Look at holders and listings on DEXs;
Review GitHub, whitepaper and the entire documentation;
Rug pulls are usually very well planned and executed. They are not always illegal, but they are always unethical. The tokens promise exciting developments and garner a lot of attention in a short span of time. This is the practice put in place by the scammers of the rug pulls according to a pump-and-dump scheme. Investors often don’t realize it until the token is drained of all value and its creators have long disappeared.
Despite how common they are, money lost in crypto rug pulls is practically never recovered, and in most cases, the scammers can vanish without a trace. For this reason, always pay attention and stay vigilant!