Rug Pull: What Is It?

Crypto is a bewildering world. New tokens and projects emerge daily, which makes spotting the right ones more difficult. Besides, with new projects, new crypto scams and rug pull incidents are also emerging. This further adds to the difficulties of the investors.

In the notorious rug pull scam, fraudsters portray the project to have a high potential and then vanish after taking investors’ funds. Disguising as a lucrative DeFi or DEX is the most common strategy for this scam.

Here we have discussed rug pulling with some tips on detecting one to avoid it.

What does ‘pull the rug’ mean?

The phrase 'pull the rug' literally means to draw out the floor under someone's feet so they fall. But, figuratively, it means leaving someone defenceless by deception.

In finance, it is a common terminology that refers to a company's stocks that promise a lot to gain investment. Then the company shuts down, selling its shares at a high price, leaving investors with valueless shares.

Rug pulling in crypto

The same goes for the crypto world too. Here, tricksters use DeFi projects to target investors in an organised way. They propose a strong roadmap, alluring investors and pumping up the price of their tokens. Once the token’s price starts gaining momentum, they dump the project, taking all the funds.

Based on its nature, a rug pull can be of three types:

1. Stealing liquidity.

2. Limitations on sell orders.

3. Pumping and dumping.

Five ways to detect rug pulling schemes

Here's how you can detect one to protect yourself.

1. Background of project developers The background of the founding members of a project can reveal a lot about it. That’s why you must check the track record of developers and founding members in the crypto industry.

The anonymity of the developers often turns out to be a strategy to hide their illegal doings. A similar kind of scam happened with Wonderland TIME, where the CFO was a convicted felon who allegedly exited with a rug pull.

2. Sell order limits Another red flag indicating the potential rug pull attempt is the limitation on sales. The scammers write a code that restricts the token holders from selling it. This can be one of the most prominent signs of a scam. That’s why you must diligently review the code before investing.

3. Total locked liquidity Locked liquidity endorses the project’s security. However, when the founders intend to rob the investors, they often do not lock liquidity in smart contracts. It allows them to swindle out all the liquidity from a DeFi.

Also, checking the project's total value locked (TVL) is advisable. Ideally, the TVL should at least be 80%.

4. Pumping and shilling Fake hype for any financial product is one of the easiest ways scammers trick investors. Through paid campaigns on social media, the founding team of a blockchain creates buzz around a cryptocurrency. Though it’s not illegal to advertise a coin, propagating false news about it is unethical.

After gaining popularity, the criminals dump these projects, leaving investors clueless. That’s why you should avoid investing in shiny-looking tokens.

5. No third-party code audits Third-party code audits are another way of gauging the authenticity of a cryptocurrency. Since developers can easily exploit the code, validation from an external source becomes necessary. Also, an audit from a trusted firm like Hacken or Certick is a mandatory procedure to assure the audience about their funds’ security.

However, fraudulent cryptocurrencies often evade third-party audits. Therefore, it is one of the ways to detect a shady token.

Bottom line

Rug pull is a prevalent scamming strategy in the crypto world. In this, the criminals strategically create false hype for a cryptocurrency to lure investors. They pump its price by generating fake positive news. As its price goes suspiciously high, they pull the rug on investors by taking all the liquidity and shutting the project.

Therefore, it is advisable to know the indicators that allow you to detect rug-pulling ventures. For this, the founders’ background, locked liquidity, advertisement campaigns, and code — require careful research.