Crypto Rug Pull: What Is It & 5 Ways To Avoid It
Key Takeaways
- A rug pull is a crypto scam where developers abandon a project and leave with the investors’ funds.
- Investing in a sound project by carrying out due diligence on the project team, project liquidity, assessing the project promises, and marketing.
- Avoid a rug pull by avoiding projects built on hype, engaging with project communities, and using trusted platforms.
- If caught in a rug pull, users should assess losses, exit positions quickly, report the scam, join community efforts, and learn from the experience.
When investing in cryptocurrencies, investors face various risks, one of which is called “rug pulls,” which are some of the harshest to experience. According to Solidus Labs, over 117,000 scam tokens were deployed in 2022, marking a 41% increase from the previous year. This translates to roughly 15 new scam tokens being detected every hour.
This article will explain what rug pulls mean in crypto, how these scams operate, and discuss five essential strategies to help an investor avoid falling victim to such fraudulent schemes.
What Is A Crypto Rug Pull In Crypto?
A rug pull in crypto refers to a fraudulent maneuver where developers of a cryptocurrency project quickly withdraw all funds from the liquidity pool, causing the token’s value to collapse and leaving investors with worthless assets. This type of scam has become increasingly prevalent in the fast-paced, relatively unregulated crypto market, attracting unsuspecting investors with promises of high returns and innovative projects.
Rug pulls are a popular tool to defraud because of the decentralized nature of cryptocurrencies, where anonymity and lack of oversight can shield bad actors from being held accountable. Many high-profile cases have resulted in significant financial losses over the years.
Investors can lose millions of dollars in minutes as the value of holdings plummets to zero. The sheer scale of these losses highlights the importance of due diligence and caution in the crypto space, emphasizing the need for investors to thoroughly research projects before committing their funds.
How Rug Pulls Work
To better understand the gravity of a rug pull one can imagine a new carnival opening in a town offering rides, excellent food, and quality entertainment. Everyone in that town gets excited to go and experience the carnival because of its promise. As a result, the town purchases tickets in advance. However, the organizers disappear on the day of the carnival with all of the ticket money, leaving just an empty field on the day of the event. This depressing situation is comparable to a rug pull in the cryptocurrency space.
But before understanding how rug pulls work, let’s understand two common types of rug pulls:
- Liquidity pulls: Continuing the previous example, imagine there’s a booth where people exchange their tickets for tokens that may be used to purchase games and rides. To ensure that everyone may exchange their tokens for tickets if necessary, the booth has a significant amount of cash. The proprietors of a cryptocurrency project abruptly remove all of the money from this booth in a liquidity pull, rendering the carnival tokens useless. Those who trusted the booth lost their money because they were left with tokens they could not exchange.
- Dump and pump schemes: Now, imagine there’s a rumor that the carnival offers a ride that will be more thrilling than the rest, and everyone rushes to buy extra tickets for that ride. But, as you found out, the carnival was a scam, and this rumor spread by the ride’s promotor was also a method to sell tickets at peak prices. Similarly, in the crypto space, scammers artificially inflate the crypto’s price to spread hype and false information (“pump”) about its growth. Once the crypto under consideration gets traction, its price rises and scammers sell large holdings (“dump”) at high prices, leaving investors with rapidly depreciating overvalued assets.
Tactics Used By Scammers To Lure Investors
Scammers are like cunning carnival barkers who use various tactics to draw in unsuspecting attendees:
- “Step right up and double your money”: They promise high returns and lure with such prospects.
- Hype and buzz: Via gaudy advertising, fake endorsements, and social media chatter, they generate enthusiasm.
- Limited-time deals: “Only accessible right now! Move quickly!” Urgency compels people to make snap decisions.
- Fake credentials: Creating false trust through the use of pseudonyms, official-looking websites, and phony endorsements.
- Early success: To encourage more individuals to invest, showcase early success stories or initial high returns.
5 Ways To Avoid Crypto Rug Pulls
There are various ways to avoid crypto rug pulls, including:
1. Do Thorough Research
An investor can begin by seeking information that developers code the investment with verifiable identities and credible track records. Users can avoid projects where the team is anonymous or has a history of failed projects.
Secondly, investors should read the whitepaper thoroughly to understand the project’s goals, technology, and economics. Legitimate projects will have clear, detailed documentation. After this, they can look for third-party security audits and code reviews.
A transparent project will undergo and publish independent security assessments to ensure that the code underlying the smart contracts is being audited and is secure.
2. Beware Of Hype And FOMO
Users should take a moment to sit and think critically. Users should become skeptical of projects promising guaranteed returns or overly ambitious timelines. Genuine projects usually provide realistic expectations and clear roadmaps. Investors should later understand that they should not rely solely on social media buzz or influencer endorsements.
Influencers often get paid to promote projects without real substance behind the blockchain. Focus on the project’s technology, use case, and development progress. Ensure the project has a working product or a clear path to achieving its goals.
3. Look For Community Engagement
Investors should look to participate in forums, Telegram groups, or Discord channels. Genuine projects will have active and engaged communities on various social media platforms like Reddit and YouTube.
Observe the quality and frequency of interactions. A robust and supportive community and regular updates from the team are good signs. Trustworthy projects are open about their progress, setbacks, and future plans. Regular updates and transparent communication from the team are essential.
4. Diversify Your Investments
Investment diversification is also a tactic to avoid rug pulls. One can balance a portfolio between more reliable, well-established cryptocurrencies like Bitcoin and high-risk, high-reward ventures by giving distinct risk profiles different priorities. This strategy might ensure that the overall impact on a portfolio is minimized, even if one investment fails.
5. Use Trusted Platforms And Wallets
Users should stick to well-known and established platforms with a track record of security and reliability. New platforms may offer attractive features but carry higher risks. Also, carry out the required and thorough research before using them.
Moreover, users can opt to increase security by switching on features like 2FA. This is nothing more than an extra layer of protection against unauthorized access.
Common Red Flags – How To Tell It May Be A Rug Pull
When looking to invest in more risky projects outside of the mainstream blockchains like Bitcoin and Ethereum, the common red flags that instantly should set of a spidey sense that the project is not trustworthy include:
- Anonymous team: Projects where the developers remain anonymous or use pseudonyms without any verifiable background information.
- Lack of transparency: Absence of clear, detailed information about the project, such as a whitepaper, roadmap, or tokenomics.
- No locked liquidity: If the project does not have a mechanism to lock liquidity, making it easy for developers to withdraw funds quickly.
- Unrealistic promises: Claims of guaranteed high returns or overly ambitious project milestones that seem too good to be true.
- Aggressive marketing: Excessive hype on social media or aggressive promotional tactics without substantial development progress.
- Poorly written code: Lack of third-party audits or security assessments of the project’s smart contracts.
Example Of A Rug Pull
OneCoin, a cryptocurrency Ponzi scheme, defrauded investors of $4 billion by promising high returns and legitimacy. Founder Ruja Ignatova disappeared in October 2017 and is now on the FBI’s Ten Most Wanted List, facing up to 20 years in prison if convicted.
Ignatova tricked victims by marketing OneCoin as the “Bitcoin killer,” while the company sold course materials and lacked a real blockchain, relying instead on an SQL server. After her disappearance, her brother Konstantin Ignatov took over but was arrested in 2019 and pleaded guilty to fraud and money laundering.
What To Do If You Get Caught In A “Rug Pull”?
Despite best efforts, rug pulls can still occur due to technological advancements and the ingenuity of hackers. If an investor is a victim of a rug pull, the victim should:
Assess The Situation
First, evaluate the extent of the losses and gather as much information as possible about the scam. Document all transactions and communications related to the project.
Cut Your Losses
Quickly exit any remaining positions to salvage what you can. The token’s value may drop rapidly, so acting fast can minimize losses.
Report The Scam
Report the incident to relevant authorities and platforms. Inform the exchange or wallet service used and regulatory bodies if applicable. This can help recover funds and prevent future scams.
Join Community Efforts
Engage with other victims and join efforts to raise awareness. Collective action can sometimes lead to legal measures or community-driven solutions to the scam.
Learn From The Experience
Reflect on the incident to understand what went wrong and how to avoid similar situations in the future. Use this experience to improve due diligence practices and investment strategies so that you won’t be in this situation again.
Conclusion
Understanding the volatile world of cryptocurrencies requires vigilance and informed decision-making. Rug pulls represent one of the most severe threats and risks, capable of financial losses for unsuspecting investors. Understanding what a rug pull is, recognizing the red flags, and employing strategies such as thorough research, avoiding hype, engaging with the community, diversifying investments, and using trusted platforms can significantly reduce your vulnerability to such scams.
Finally, should one want to invest in the crypto market somehow, but all this is too tedious to ensure safety, it is encouraged for that individual to buy cryptocurrencies from a reputable exchange such as Kraken or Coinbase. Finally, the individual should learn to self-custody in a non-custodial wallet.
FAQs
Perpetrators may face legal consequences, reputational damage, and community backlash, but often they escape unpunished due to the anonymity of crypto. Yes, one can sue for rug pulls, but legal action can be complex and challenging due to jurisdictional issues and the anonymous nature of perpetrators. Yes, rug pulls are illegal as they involve fraud and theft, violating securities and investment laws in many jurisdictions.What happens if you rug pull?
Can you sue for rug pulls?
Is rug pull illegal?
