Crypto-related crimes broke new records last year with a 79% increase and damages of $14 billion in total. Rug pulls emerged as one of the most trending scam types with over $2.8 billion stolen from victims of DeFi protocols.
Rug pulls might be quite difficult to spot, but there are also tricks to detect and recognize malicious intentions.
What Is a Rug Pull in Crypto?
A rug pull is a type of scam where developers or creators of the token run away with the investors’ funds.
Typically it happens when the scammers create a legit-looking cryptocurrency project, release a token based on a promising concept, and list it on decentralized exchanges (DEXes). When the value of the token increases, scammers simply pull out all the allocated funds and quickly abandon the project.
Put simply, a rug pull is just a newer version of exit scams, which have been in the cryptocurrency space since its inception, and highly increased during the boom of initial coin offerings (ICO). Fraudsters also used to disappear with investors’ funds back then, during or after the fake ICO, based on a promising concept.
How Does a Crypto Rug Pull Happen?
The popular playground for rug pull scammers are decentralized exchanges (DEXes) and liquidity pools, which play a critical role in decentralized finance (DeFi).
DEXes do not require strict audits for newly-listed tokens. Anyone can list their tokens, and this is one of the reasons why they are an easy target for scammers.
Another reason is the decentralized nature of liquidity protocols that act as a market maker for DeFi. They have no centralized body to facilitate trades; all buy and sell orders are set and run on smart contracts.
But to enable trades, there must first be liquidity. Liquidity is provided by a pile of investors, who lock their funds in various cryptocurrency pairs.
Anyone can create a liquidity pool for the new trading pairs by locking a certain amount of capital.
When a liquidity pool is created, the scammer lures the investors to buy their tokens and locks them into the liquidity pool to generate yields. It depends on scammers’ imagination what tactics they use to attract the victims. Extremely high yields are one of their common tricks.
So, whenever the price of the token increases, the scammers pull out the entire amount locked in the liquidity pool.
Typically, they apply a special code that disables investors’ ability to sell their fraudulent tokens back to the exchange. In the meantime, the scammer is fully capable of operating and exchanging all digital assets.
How to Recognize a Potential Rug Pull
Although common, rug pulls can be hard to spot. The good part is that crypto investors have become smarter and more trained to identify suspicious signs.
Here is what they have learned about recognizing cryptocurrency rug pulls:
Hype out of nowhere
It should be a red flag to investors if a relatively new token suddenly appears all over social media and creates massive hype around itself. The hype is typically based on a token’s potential or impressive yields that seem “too good to be true.” Hype is a common tactic that scammers use to inflate the value of their token, which in reality is fake and a hoax.
Scammers need bait to catch victims quickly. Their typical bait includes promises that are hard to resist. The revolutionary narrative, extremely generous return projections, and guaranteed profits are rug pull scams’ consistent features. So, if the promises sound too good to be true, it’s safer to stay away.
No code audit
Tokens should undergo smart contract audits to ensure that they are ready to act as a proper investment tool. An audit aims to uncover if there are any bugs or other security flaws in the code. Audited crypto projects always publish audit reports on their media channels and provide a link to the auditor’s company. Cryptocurrency projects that do not share their codes and ignore code-related security alerts on their media should raise a red flag.
The team behind any new crypto project is critically important. If the project is legitimate and has no decisive plans upon its sleeve, there’s no need for the founders to hide their identities. Anonymous team means inability to trace it in case something happens. It indicates no responsibility and is considered a major red flag.
Fraudulent projects are not long term, thus scammers do not put much effort into them. You can see this from the vague whitepaper, the key document of any crypto project that includes strategy, goals, and market analysis. If the project does not share its whitepaper or provides a very abstract one that is similar to the promo material, it’s better to stay away from such a project.
Shady or unrealistic roadmap
A proper cryptocurrency project has to prove to investors its serious intentions and abilities to implement plans. A project’s roadmap allows for the evaluation of its current achievements and also future development plans. If the roadmap is abstract or there is no roadmap at all, a rug pull might be the team’s only plan for the future. Also if the roadmap declares unrealistic future development plans, but the project has not achieved anything significant yet, consider this as another alert.
Listed on DEXes only
Centralized crypto exchanges apply strict listing policies and require new tokens to meet their requirements. It also is quite a long process, thus scammers do not invest their time or capital and mostly list tokens only on decentralized exchanges.
Most of the liquidity pools lock their digital assets for a certain time period. This is a necessary step to provide confidence to liquidity providers and safeguard them from rug pull risks. If the pool remains unlocked, malicious developers might drain the assets out and leave investors with nothing.
Scammers tend to keep a huge part of the token supply for themselves. If a large percentage of tokens sits in the wallets of a few holders, there is a chance of potential rug pull or price manipulation at least. Check the token allocation on websites like Etherescan or BSCScan. If there are few holders but with massive token amounts in their wallets, take this as a warning sign.
Low liquidity and trading volume
A healthy trading volume should linger within the range of 10% to 40% of the asset’s market capitalization. A low 24-hour trading volume indicates low liquidity. If the volume is below the 10% mark, it probably signals that there are not enough assets locked into the liquidity pool. Do your research on why that is: maybe the project is very young or the liquidity is not locked. Information on the pools’ liquidity is usually available on the legit DEXes.
To summarize, studying fundamentals and doing your own research before investing is crucial. It is the only way to stay critical and not fall victim to cryptocurrency scammers.
A rule of thumb says when in doubt follow your gut. If you feel an urgent impulse to buy, just because your favorite YouTube star promoted a token, it is always better to wait. Give yourself at least a few days or a week to research and observe its price movements.
Why You Should Care
Digital currencies are less regulated than other investment assets like stocks, real estate, or commodities. This means, that the scammers will also stay a part of this space. Furthermore, with the growing crypto adoption, we might see an increase in crypto rug pulls in upcoming years. Thus we must stay diligent.