How to Detect a Crypto Rug Pull
Paul has been waiting for his breakthrough since he began investing in cryptocurrencies. After 3 years of ups and downs with several tokens, his friend introduced him to Sapacoin, a token that has amassed a massive spike in value within a short period of time.
Paul has monitored the movement of Sapacoin to make sure it is not a fluke. Realizing that he might be wasting too much time overthinking the entire trade, he goes all in, spending most of his portfolio investing in Sapacoin. He goes to bed with the assurance that by the next morning, he should be able to buy a brand new Range Rover.
In less than 24 hours, Sapacoin “magically” does the unthinkable. The value absolutely tanks to nothing and Paul wakes to the reality that he might be in serious financial trouble, and not the largesse he had dreamt of.
Welcome to the ugly reality of Rug Pulls.
It’s amazing how much range the fraud industry has. Perhaps one of the oldest professions in the world, fraudsters exist across different industries around the world, and unfortunately, crypto isn’t left out.
Rug pulls have caused billions of dollars in losses for investors and despite its reputation, it isn’t really hard to spot these scams.
What is a Rug Pull?
A rug pull in crypto simply means a project that scams investors out of their money. Specifically, it refers to when project developers dump all their tokens into the open market causing a massive price drop and the effective end of a project. In essence, the scammers pull the proverbial rug from under investors that they’ve lured in with promises of lucrative returns — and quickly disappear with their funds.
Rug pulls are absolutely annoying as they usually target risk-takers seeking to invest in potential unicorns before they go mainstream.
According to CipherTrace, rug pull scams stole a whopping $361 million between January to July 2021. For context, this is a nearly three-fold increase when compared against data from 2020.
In addition, rug pulls also account for nearly 77% of all crypto-related hacks.
Types of Rug Pulls
There are currently three types of rug pulls to look out for in the crypto space. They include:
- liquidity theft
- limiting sell orders
- pumping and dumping
A liquidity theft is simply when the founder of a crypto project suddenly withdraws all the coins from the liquidity pool that’s being used to fund a project.
Limiting sell orders aren’t as direct as liquidity thefts. Here, the scammer codes a token with a smart contract that makes them the sole authority in authorizing sales. In essence, only the developer can sell the tokens in the pool.
Pumping and dumping is probably the most popular scheme in rug pulls. A dump is defined as the process in which a developer sells off a significant amount of tokens from their portfolio.
So how can you spot a Rug pull? These signs should raise a red flag or two for investors.
Their Founders Are Usually Hidden
As most scammers love anonymity, a potential rug pull will shield the identities of its creators. Now, pseudonyms aren’t new to crypto. For example, The Bored Ape Yacht Club launched with the identities of its developers hidden and still went on to become largely successful. Same with Bitcoin. Unfortunately, all rug pulls share this trait, making it harder for investors to separate the wheat from the chaff.
To avoid falling for a scam rug pull, investors must rigorously research the origins of the token being pushed. Stakeholders must also determine the real identities of developers of the token they wish to invest in before diving in.
No Liquidity Lock
This is perhaps the easiest tell for a rug pull. If a token supply has no liquidity lock, the only thing stopping the developers from fleeing is their goodwill.
Real crypto projects usually force founders to lock their liquidity (money) with a third party for certain periods of time.
Locked liquidity means that the tokens given to developers can’t be sold for a certain amount of time. This prevents the team from immediately dumping the tokens and ensures the long-term growth of the project.
As the elders say, if it’s too good to be true, it probably is. This mostly applies to decentralized finance protocols. If the project is promising way more returns than it should as an unknown token, there’s a good chance your legs are being pulled.
Uneven Token Distribution
If a few wallets in the crypto project hold more than 20% of available tokens, there’s a chance that it might be a scam. Some rug pulls distribute the tokens across several wallets to throw investors off their scent ahead of time. To avoid this, investors need to investigate the coin’s blockchain explorer on Etherscan or BSCscan to find its token distribution.
Rug pulls will continue to pose a major problem until there’s greater awareness and regulations in the crypto space.
Overall, a rug pull like any other scam relies heavily on the ignorance of its victims. The old adage; look before you leap comes into play. Before you invest in any crypto project, it is important to do a solid background check. This will save you from the hassles of financial loss and ruthless scammers.