Rug pulls in the crypto world refer to a malicious maneuver in decentralized finance (DeFi) where crypto developers attract investors into an idea centered around DeFi after which they abandon said project to run away with investors’ funds.
The theory behind rug pulls often relates to the abuse of trust by bad actors using DeFi projects to raise funds from investors. This means that developers may create tokens or projects that seem legitimate, but once they accumulate a substantial amount of investment, they “pull the rug” by draining the funds from the project.
Rug pulls exploit the decentralized nature of blockchain, where there’s often no central authority to oversee transactions and the anonymity of parties involved to benefit the bad actors.
Here are some reasons why rug pulls are prevalent in DeFi:
Many blockchain transactions can be conducted pseudonymously, and project founders can often hide their real identities. This makes it difficult to hold anyone accountable if a project turns out to be a scam.
The crypto space, especially DeFi, operates with minimal regulatory oversight compared to traditional financial markets. This lack of regulation provides a fertile ground for fraudulent activities.
With platforms like Ethereum and BNB Smart Chain, creating a new token can be done with little technical knowledge and at a low cost, allowing scammers to set up projects with the sole intent of defrauding investors.
The crypto market is driven by hype and speculation. Scammers exploit it by promoting their tokens through social media and paid influencers, creating a false sense of legitimacy and potential for high returns.
Many new and inexperienced investors are drawn to the high returns promised by these projects without the knowledge or experience to conduct proper due diligence.
While decentralization is a core tenet of blockchain and crypto, it also means there’s no central authority to oversee project legitimacy, leaving the door open for scams.
The rapid rise in value of some legitimate cryptocurrencies creates a fear of missing out among investors, who may then invest hastily in projects without proper vetting.
In DeFi, liquidity is often provided by the token creators, who can withdraw it at any time. This design can be exploited by scammers who drain the liquidity pool, leaving investors with worthless tokens.
Some rug pulls are executed by exploiting vulnerabilities in smart contracts, which are not always thoroughly audited or secure.
Many investors do not understand the blockchain technology or the risks involved in crypto investments, making them easy targets for scammers.
There are several variations of how crypto rug pulls can take advantage of its victims. These include:
The developers create a cryptocurrency and pair it with a reputable coin on a decentralized exchange. They then withdraw the entire pool of funds, leaving investors with a worthless token.
Example: One of the most infamous examples is the case of “The Big Coin”. The creators promoted the project extensively, and once a significant amount of funds were invested, they withdrew the entire liquidity pool, leaving investors with valueless tokens
In this scenario, the project’s code is manipulated to prevent investors from selling their holdings after a certain price is reached, allowing only the creators to sell off their share at the inflated price.
Developers or insiders hype up a new project to inflate the price, then sell their substantial holdings, crashing the price and leaving other investors with a devalued asset.
Considering the array of tactics malicious entities employ to deceive investors through crypto rug pulls, it’s evident that these schemes typically unfold in one of two primary patterns:
Whereby developers utilize deceptive coding practices to steal from investors. Bad actors will insert secret backdoors or functions within a smart contract that activate once funds are invested. Consequently, users find themselves unable to interact with their assets, effectively trapping them in the project while the fraudsters gain complete control to manipulate the tokens.
Outlines a situation characterized by its “pump and dump” strategy. Investors will retain the option to withdraw from the project at will, yet the fear of missing out on substantial gains keeps them invested. This hesitation allows the project’s initiators to depart with the accumulated wealth.
Detecting rug pulls to safeguard investor funds is an important tool to navigate investing opportunities in the crypto space. Strategies that may be adopted to maintain a healthy dose of skepticism include:
Look for projects with transparent team members. Verify the individual teams past experience and credibility through professional networks like LinkedIn. Avoiding projects with anonymous team members is considered to be a good route to choose reliable projects before investing.
An individual should aim to run a comprehensive audit report from a reputable security firm. This audit should utilize tools like Etherscan to verify the legitimacy and security of the smart contract code.
Ensure liquidity is locked by checking the terms on trusted platforms such as Unicrypt or directly on the blockchain. Liquidity locks prevent the team from pulling out the liquidity suddenly or draining the project’s account unlawfully.
A project’s legitimacy can be tested by reviewing the activity level and transparency of communication within its community channels and social media platforms. An engaged community and responsive team can be a good sign that the project is legitimately seeking to solve a problem that will lead to growth of that project.
Look for a project with a solid track record or verifiable history. Be wary of new projects that promise high returns quickly and get rich quick schemes. These projects may likely be trying to scam individuals out of their investor funds.
A project should make credible partnerships or endorsements with other larger companies and these partnerships add an extra layer of legitimacy and credibility to the project on offer. This means investors should carry out the necessary due diligence to ensure these partnerships are indeed true and are not fabricated.
It is important for any investor to carry out the required fundamental analysis on the project by reviewing and reading the whitepaper discussing the project proposal. This means a thorough and realistic whitepaper should outline the project’s goals, strategy, and technical details. It should not be vague or overly promotional.
Some real-time case studies and examples of ‘rug pulls,’ where investors faced substantial losses due to deceptive practices by project developers.
In 2014, the OneCoin rug pull was one of the most notorious scams in the history of cryptocurrency. OneCoin was presented to investors as a revolutionary digital currency that would rival Bitcoin. OneCoin claimed it had a private blockchain, unlike other cryptocurrencies that use public and decentralized blockchains. The scheme was marketed globally through a network of promoters and held events to attract investors.
It was later revealed that OneCoin did not have a blockchain at all and the entire operation was a Ponzi scheme. Essentially, older investors were paid out from the investments of new entrants to the scheme. The scale of the scam was massive, with estimates suggesting that it garnered as much as $4 billion from investors worldwide.
The scheme began to unravel when authorities and journalists started investigating and exposing the lack of a genuine blockchain and the unsustainable structure of the returns promised.
In 2021,Thodex , a Turkish cryptocurrency exchange, was in the news when its founder disappeared, allegedly taking with him around $2 billion of investors’ money. This incident left a trail of financial loss for investors who believed their funds were secure on the Turkish exchange platform.
The exchange, which had operated like a legitimate hub for trading digital currencies, became the center of one of the largest suspected fraud cases in cryptocurrency history. The case against Thodex continues to unfold as investigators delve into the complex web of transactions in an attempt to locate the missing funds and hold the responsible parties accountable.
In 2023, the BALD token emerged as a meme coin within the crypto space, quickly becoming notorious for its dramatic rug pull. Initially, the BALD token saw a staggering 4,000,000% price surge, attracting over $68 million from hopeful traders. On-chain evidence linked this token’s deployer contract to wallets associated with Alameda Research, a firm founded by crypto personality Sam Bankman-Fried (SBF). The sharp price increases were soon followed by a liquidity withdrawal, causing a 90% token value collapse and trapping investors’ funds.
The rush to invest in BALD occurred on the Base blockchain, developed by Coinbase, which interestingly was yet to officially open to the public. The frenzy contributed to a brief capital influx, with BALD’s market capitalization momentarily reaching $85 million. However, the excitement was short-lived as the liquidity was abruptly pulled, leading to significant losses for traders.
Investigations into the incident have cast doubt on SBF’s direct involvement, considering his restricted internet access due to bail conditions from previous legal issues. Yet, the incident has raised concerns over Alameda Research’s potential complicity in the BALD token scandal, contributing to the ongoing discourse on the need for more stringent oversight in the DeFi sector.
AnubisDAO became a cautionary tale in the crypto space when, shortly after raising $60 million from investors through a token sale, the project’s liquidity was abruptly drained. This sudden withdrawal left investors with worthless tokens and a vanished investment, marking yet another stark example of the vulnerabilities within the DeFi ecosystem.
The DeFi100 coin incident stands as a rug pull made in 2021, where reports surfaced alleging that the creators declared they had conned investors out of $32 million. The DeFi100 coin case underscores the critical need for investor vigilance in the face of potential digital currency frauds.
Safereum’s developers executed a rug pull, running away with funds post a $600,000 presale. The team later deleted their online presence, leaving the Safereum token’s value to crash by 94% . Crypto influencers were criticized for inadequate due diligence, after pushing the project to their respective followings. It is therefore highly recommended that individuals carry out their own due diligence before blindly trusting a crypto influencer.
Luna Yield emerged as a high-profile project within the Solana ecosystem, promising lucrative yield farming opportunities to its investors. The platform quickly gained traction and visibility, attracting significant funds from users enticed by the potential for high returns. However, the project’s legitimacy came into question when, without warning, the website and all associated social media accounts were abruptly taken offline.
The developers behind Luna Yield had vanished, taking with them the funds of countless investors. While the exact amount lost has not been specified, the impact was substantial, given the platform’s prior standing and the level of trust it had garnered. This incident serves as another cautionary tale of the risks inherent in the burgeoning DeFi space.
Crypto rug pulls are a harsh reminder of the inherent risks associated within the DeFi space. As the future of finance evolves with the increased adoption of blockchain and cryptocurrency, robust due diligence practices becomes an essential behavior that investors should practice before deploying their hard earned capital into the DeFi space.
As a result, to ensure a safer investing environment, a collaborative effort among investors, developers, and regulators is required, to ensure transparency and provide education on spotting and dealing with rug pulls effectively.
What is a Crypto Rug Pull?
A crypto rug pull is when DeFi project developers abandon a DeFi project after attracting investment through deceitful marketing strategies. Rug pulls scam investors by running away with the funds.
Why do Rug Pulls Happen?
Rug pulls exploit the decentralized nature of blockchain and the anonymity of developers, allowing them to commit fraud without accountability or regulatory oversight.
How can Rug Pulls be Prevented?
Investors can prevent rug pulls by verifying developer identities, auditing smart contracts, checking liquidity locks, assessing community presence, and critically reviewing project whitepapers.
What are Some Notable Rug Pull Examples?
Notable rug pulls include OneCoin in 2014 with a $4 billion scam and Thodex in 2021, where the founder vanished with an alleged $2 billion of investor money.