Rug pull in the crypto world and how to avoid it

With hundreds of new cryptocurrency projects launched every single day, it’s not too surprising that only a small percentage go on to be a huge success. Sadly, the majority don’t stick around for long before they disappear, and that is to be expected in what is an incredibly competitive market. We should also be aware of the fact that some projects are built to fail.

These are the projects that the cryptocurrency industry often refers to as “rug pulls.” They are essentially scams set up to defraud investors, and it goes without saying that you should avoid them at all costs. So, what exactly is a rug pull, and how do you ensure that you don’t become a victim of one? Find out in this AAG Academy guide.

What is a rug pull in crypto?

The phrase “rug pull” comes from an English idiom. If you were to “pull the rug out from under someone’s feet,” you are leaving them to fall without support or assistance. And that’s essentially what happens with certain cryptocurrency projects that are designed to fail from the very beginning — usually to steal money from unsuspecting investors.

Rug pull projects look like any other cryptocurrency project on the surface, and they are marketed in much the same way. The project’s creators encourage people to invest their cash with the promise of exciting and ambitious plans, and once they have received enough money, the creators usually take off with the liquidity pool and leave the project to die.

Those who invested end up with tokens that are worthless and no way of getting their money back. And because there is so much anonymity within the cryptocurrency industry, it is rare that the scammers ever get caught. With that in mind, rug pull projects are something you want to steer well clear of. To do that, you need to understand the different types of rug pull.

What types of rug pulls exist?

There are three common rug pull types all cryptocurrency traders should be aware of. These are:

Liquidity theft
Liquidity theft, which we touched upon in the example above, is one of the most common types of rug pull. It’s when the creators of a cryptocurrency project suddenly withdraws all of the funds from the liquidity pool that’s used to fund the project — usually, after a considerable amount has been invested into it. When this happens, all of the project’s value is removed.

Limit sell orders
Limiting sell orders is a much more subtle type of rug pull. This is when a project’s creators use a smart contract that allows only them to sell the project’s token. This tactic traps investors into the project and leaves them with an asset that they are unable to sell or trade themselves, so only the creators can earn a profit.

Pumping and dumping
Pumping and dumping is the term used to describe the process by which project creators quickly sell off (dump) significant amounts of the project’s token, usually after others have invested and the value has risen (pumped). This allows them to earn a profit, but drives down the price of other tokens, so that everyone else suffers a loss — or cannot sell at all.

‘Celebrity’ giveaways
In the past, a number of high-profile celebrities have supposedly offered up millions of dollars worth of cryptocurrency tokens — almost always Bitcoin because it’s the biggest and most exciting — to their followers on social media. They say that all you have to do to claim it is send some of your own cryptocurrency to their address, and they’ll send back double.

The likes of Elon Musk, Bill Gates, Jeff Bezos, and even Kanye West have run these “giveaways” on social media in recent years. There’s just one problem. They’re all a scam. The messages are posted by hackers who gain access to a celebrity’s social media accounts, then use it to rob unsuspecting fans of their valuable Bitcoin tokens.

Any Bitcoin sent to the addresses provided stays there and never comes back. Don’t fall for these tricks. Celebrities don’t just give away millions of dollars worth of cryptocurrency to random followers, no matter how wealthy they might be. If an offer sounds too good to be true, it almost always is.

Hard pull vs. soft pull: What’s the difference?

In addition to the three tactics outlined above, we have what’s called a “hard pull” and a “soft pull.” Hard rug pulls occur when developers use hidden code in a smart contract to create a “backdoor,” which can later be used to pull all funds. This code is there from the very beginning of the contract’s launch, which indicates it was always the creators’ intention to walk away with the cash.

A soft pull occurs when a project’s creators dump their own tokens quickly, leaving a severely devalued project with no future in the hands of remaining investors. Although this may have been their intention from the beginning, it sometimes happens with legitimate projects that have simply run out of steam. Creators cannot see a way forward, so they take what they can and leave.

As you’ll see in the chart below for Squid Game — an obvious scam token — the clearest indication of a hard pull is a complete and irreversible loss of value. The price of the token drops to zero immediately, and investors lose everything. You usually find that any websites and social media channels related to the project quickly disappear as well.

Image : CoinMarketCap

The first sign of a soft pull is a similar decrease in value, but it usually happens over a longer period of time, as you’ll see in the chart below for Polywhale. The project’s creators sell off their tokens first, causing a significant but not complete drop, but others quickly follow suit when it becomes apparent that a soft pull has occurred. Some investors may salvage some of their money if they sell quickly enough, but others will lose everything.

Image : CoinGecko

How to spot a rug pull

No cryptocurrency trader wants to be the victim of a rug pull, and although some, particularly soft pulls, are difficult to avoid, there are some steps we can take to protect ourselves. Here are a list of things you should look out for before investing in a new cryptocurrency project:

Locked liquidity
When a cryptocurrency project has a locked liquidity pool, its funds are secured through time-locked smart contracts, some of which could run for up to five years. In other words, the money in the pool (or at least large portions of it) cannot be withdrawn until those contracts expire. A project without locked liquidity does not have the same protection, making it much easier for creators to take off with the cash.

It should be noted that developers can create their own time-locked contracts that could be designed to be exploited at some point. But when third party locks are used, like those offered by a decentralized exchange, the project is likely to be a much safer investment.

External audits
Trusted cryptocurrency projects, even new ones, are now increasingly likely to have been audited by a reputable, independent company. Even decentralized exchanges make this a requirement now. Auditing is when the project’s code is examined to ensure there are no backdoors or other secret flaws that developers can take advantage of to steal liquidity later.

You shouldn’t trust a project that has not had an external audit. And when a project claims they have been audited, you should be able to verify this by seeing the report on the auditor’s website.

Limits on sell orders
Some cryptocurrency projects will impose limits on sell orders, making it more difficult for investors to sell their tokens. Usually, those limits are only in place to lock investment cash so that project creators can take more for themselves in the future.

Sadly, it’s difficult to identify whether limits on sell orders are in place. One of the simplest ways to find out is to make a small investment in the token, then immediately attempt to sell it. If you are unable to sell, it’s likely because the developers designed it that way, and the project is likely a scam.

Anonymous creators
One of the great things about the cryptocurrency industry is the ability to trade somewhat anonymously. Unfortunately, it’s relatively easy for project creators to remain anonymous, too — and when they do, it’s often because they do not plan on sticking around and do not want to be traced.

Not all anonymous projects turn out to be scams. Just look at Bitcoin, the most valuable cryptocurrency in the world, whose developer “Satoshi Nakamoto” remains anonymous to this day. But things are different in the modern cryptocurrency industry, and an anonymous team is usually one to avoid.

Strange price movements
If you look at the value of a new cryptocurrency project and something just doesn’t add up, that could be a sign that it’s not genuine. Big fluctuations in token price, particularly when the value of a new coin rises rapidly, should be viewed with skepticism. This is often a sign that developers are pumping up the price of the token before they dump their share and move on.

Use your best judgment

One of the most critical steps you can take to avoid rug pulls and other scams in the cryptocurrency industry is to use your best judgment. Although we’ve outlined the most important things to look out for above, nothing beats trusting your gut. Carefully research the projects you’re interested in, and only invest in those you trust.

It’s also important to bear in mind that there are no guarantees when it comes to trading. Even the most legitimate projects sometimes encounter hurdles they simply cannot overcome and end up failing, leaving investors with little to show for their support. Be aware of the fact that there is always a risk, and not every venture will be profitable.

References

• Rug Pull in Cryptocurrency and How To Avoid It
• Saiba o que é ‘rug pull’, golpe que tem afetado investidores de cripto
• Veja como funciona o “rug pull”, golpe que vem crescendo no mundo das criptomoedas
• Rug pull
• Rug Pulls: Hard vs Soft Rugs
• What is a Soft Rugpull vs a Hard Rugpull?