Imagine you’re walking on the red carpet—happy and confident—waving at the cheering crowd.
But suddenly someone suddenly pulls the carpet under your feet and you fall on your face.
Wouldn’t that be horrible?
This is what has happened to many crypto investors when some scammer shattered their dream of making money. This is called a rug pull.
A rug pull is a crypto scam that happens when a team behind a project pumps its token and then abandons the project, sprinting away with the money. It leaves investors with a valueless asset.
Rug pulls are a type of exit scam that usually happen in the decentralized finance (DeFi) ecosystem. The practice is most commonly practiced on decentralized exchanges (DEXs), which allow tokens to be listed for free and without audit, unlike centralized crypto exchanges. Scammers create a token that’s listed on a DEX, then pair it with top cryptocurrencies like Ethereum.
There are different types of rug pulls.
- Liquidity stealing: This is the most common type of rug pull where creators withdraw all the tokens from the liquidity pool. As a result, the value of all the currency goes down to zero.
- Limiting sell orders: This is a sophisticated type of rug pull in which a malicious developer embeds codes to prevent the selling of tokens or to prevent investors from cashing out. The moment they see enough positive price movement, they dump their positions, leaving a worthless token behind. An example of this is the Squid Token scam.
- Dumping: Sometimes, developers sell their own tokens. As a result, the price of the token drops sharply, and the remaining investors are left holding worthless tokens. It typically occurs after a big promotion on social media.
If investors are aware of the ecosystem, they can avoid rug pulls.
- Check the liquidity: Decentralized exchanges, such as Uniswap, determine the price of tokens in a pool using an algorithm based on the balances available. To avoid being a victim of a rug pull, ensure there is adequate liquidity in the pool, and it’s locked. A locked liquidity pool ensures that a project has credibility and there will be enough money in the pool for a certain time period to determine the price of the token.
- Check the developer: Although the crypto world is all about anonymity and people behind the projects don’t show their faces, investors must read and try to find out who is behind the project and their past experiences. For that, they can read websites, telegram channels, whitepapers, and other media to check the project’s legitimacy.
- Skyrocketing price: Sometimes, the price of a newly launched token can soar in a single day, becoming the leading gainer of the day. However, these tokens have relatively few token holders. Investors can use a block explorer to check how many investors hold the token. If the number of token holders is smaller in number, that means there are a few whales betting on the token, and they can dump it whenever they want.
- Extraordinary high yields: Crypto projects claim to offer better returns than stocks, and some of them are true. However, investors should always be skeptical of high yields, especially from new tokens, as it could be a Ponzi scheme. A high annual percentage yield (APY) can turn into a high risk.
- Audit: Most crypto projects undergo a formal audit process from a third party, and they show it on their platform. Before investing in any project, one must check the audit report and make sure that it’s legitimate and safe for putting money.
The bottom line
The DeFi space is growing, and so is rug pull. One must do research and discuss with experts on platforms before putting money in because a) not every rug pull is illegal, some are unethical, so it’s difficult to fight for it, and b) since the space is anonymous, it’s difficult to identify who committed the crime.