What Is a Rug Pull Scam and How to Avoid It?

UTC by John Caroline · 7 min read
What Is a Rug Pull Scam and How to Avoid It?
Photo: Depositphotos

Crypto users and investors often become victims of rug pull scams, which causes them to lose heavily on their funds. Here’s a guide to know more about rug pull scams and how to avoid them.

In a world where some consider it a worthy mission to rip people off their earned funds to satisfy their selfish desires, different kinds of fraudulent schemes have been emerging over the years. Cyber activity has significantly increased with the expansion of the crypto industry. Just like the frequency of physical theft and robbery, rug pull scams have become rampant, leaving investors to panic over the consequences of being a victim.

It is correct to say that fraudsters and malicious actors have their targets fixed on the crypto industry considering its exclusive potential to create wealth. Hence, it seems as though crypto users are the most victims of rug pull scams over the years. To help keep investors vigilant and aware of necessary measures to take, here is a guide giving full details on what a rug pull scam is and describing ways to prevent it.

Rug Pull Scam Defined

To start with, let’s understand what a rug pull is. The term is coined from the phrase “pulling the rug out”. Rug pull scam is a popular type of scam where the team that establishes a decentralized finance (DeFi) project abandons the project after disappearing with the investors’ funds by selling or acquiring all the crypto assets poured into a liquidity pool and locked into a smart contract.

In this situation, developers often lure investors to a new cryptocurrency project and then abandon them with worthless currency before the project is completed. They are often common with decentralized finance projects that attempt to disrupt industries like banking and insurance. This often happens because DeFi tokens can be created easily and then listed on DEXs with little to no KYC or AML.

In other words, anyone can set up a liquidity pool, and even an IDO with basic due diligence checks still has a high level of risk. Many crypto projects are anonymous, making it easy for a team or owner to rug pull without risking their identity.

Types of Rug Pulls

Below are the various types of rug pull scams often deployed to run off with investors’ funds:

  • Liquidity stealing. As the name implies, this type of rug pull scam happens when token creators or developers steal or drain all of the coins from the liquidity pool. Thus, it is regarded as liquidity stealing. This effectively destroys all of the value that investors have invested in the currency, causing its price to decline to zero.
  • Limiting sell orders. In this case, the tokens are coded by the developers so that they are the only ones who may sell them. The developers then wait for retail investors to use paired currencies to buy into their new crypto. They dump their positions once there is enough favourable price action, leaving a worthless token behind.
  • Dumping. This rug pull scam occurs when developers immediately sell off their enormous number of tokens, this is known as dumping. As a result, the price is reduced, and investors remain with worthless tokens. Notably, dumping is more of an ethical grey area than the other DeFi rug pull scams. Simply put, it is likely ethical for crypto developers to buy and sell their own currency. However, it becomes an act of “dumping,” when it comes to DeFi cryptocurrency rug pulls, considering how much and how quickly a coin is sold.

Hard Pulls vs Soft Pulls

It is important to note that rug pulls can either be hard or soft, hence it is crucial to understand the difference between hard rug pulls and soft rug pulls.

Hard rug pulls occur when project developers code malicious backdoors into their tokens. Malicious backdoors are hidden exploits that have been coded into the project’s smart contract by the developers. The intent to commit fraud is clear from the get-go. Liquidity stealing is also considered a hard pull.

Soft rug pulls refer to token developers dumping their crypto assets quickly. Doing so leaves a severely devalued token in the hands of the remaining crypto investors. While dumping is unethical, it may not be a criminal act in the same way that hard pulls are.

How to Spot a Rug Pull

There are certain things to consider in order to be able to discern situations of rug pulls. Some of the things to consider in order to spot a rug pull scam include:

  • Investigating the project’s team and white paper’s legitimacy. In order to spot a rug pull, investors should spend enough time to know more about the team behind the project. This will not only help to identify a rug pull but also help to establish the intrinsic value of the project and provide all the necessary information. Notably, you can consider it a red flag when developers or the team makes their identity discrete and anonymous. Moreso, the white paper of the crypto project aids in establishing its legitimacy, as a valid and lawful cryptocurrency project’s white paper will contain all detailed information.
  • No liquidity locked. One of the crucial and easy ways to distinguish between a scam and a legitimate cryptocurrency project is by checking if the cryptocurrency is liquidity locked. Nothing prevents the project founders from increasing the token supply if there is no liquidity lock-in effect.
  • Limits on sale orders. A malicious project codes a token in such a way as to prevent confident investors from selling while allowing others to do so. These selling limits are typical of a scam project.
  • Massive price pump with a limited number of token holders. Sudden substantial price swings in a new coin should be approached with caution. If the token has no liquidity, the chances of a scam are prevalent.
  • No external audit. New cryptocurrencies are expected to be subjected to a formal code audit by a credible third party. A third party should be able to verify the audit.
  • Analyzing transaction and on-chain data. A crypto asset’s on-chain activity is available in the blockchain network. This covers recent trading volume, liquidity, and the number of DEXs registered as legitimate crypto assets. It is likely a rug pull if the project appears only in a few DEXs and has little trading activity.

Avoiding Rug Pulls

It is often easier to avoid rug pulls if one is able to carefully observe a project to identify if it is a rug pull or not. Take into proper action the aforementioned ways to spot a rug pull and make possible measures to avoid a project with one or more red flags.

The legitimacy and genuineness of the project and its team should be properly investigated before venturing into them. Be sure that the company does actually exist and has a registered address for safety reasons.

Also, it is important to avoid FOMO pressures when seeking to invest in a cryptocurrency. Usually, one of the ways that fraudulent investors set up a project to be rug-pulled is through fear of missing out. One must match the data they have with the latest asset news. Be aware that excessive advertising content can indicate rug pull as most new coins will start slowly and small.

Bottom Line

Just like other fraudulent schemes, rug pull scams have caused lots of crypto investors to lose their funds mysteriously. These bad actors have their eyes fixed majorly on the crypto industry due to the advanced technological models often adopted in the industry and its exclusive potential to make wealth.

Hence, it is expedient for investors, especially crypto users to learn and understand the necessary indications of rug pull scams while also avoiding and protecting their funds against them.

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FAQ

What is a rug pull scam?

Rug rull scam is a popular type of scam where the team that establishes a decentralized finance (DeFi) project abandons the project after disappearing with the investors’ funds by selling or acquiring all the crypto assets poured into a liquidity pool and locked into a smart contract. 

How does a rug pull work?

It happens when developers often lure investors to a new cryptocurrency project and then abandon them with worthless currency before the project is completed.

What are the different types of rug pulls?

The different types of rug pulls include liquidity stealing, dumping, and limiting sell order.

How to identify a rug pull?

A rug pull can be identified via the following measures:

  • Investigation of the project’s team and white paper’s legitimacy;
  • no liquidity locked;
  • massive price pump with limited token holders;
  • analyzing transaction and on-chain data.

How to protect against a rug pull scam?

One can protect against a rug pull by carefully observing the project to identify if it is a rug pull or not. If one or more red flags are observed, one should make sure not to get involved with the project nor get influenced by FOMO.

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