The Art Of The Rug Pull In Crypto
When the rug gets pulled out from under you
Even if you’re not a regular Netflix viewer, you will undoubtedly have heard of Squid Game. The viral TV series attracted record-high views in a few weeks when it was released in September 2021.
Unfortunately, the massive hype gave way to a short-lived scam that capitalized on the popularity of the drama series, despite having no real association with it. A crypto scam project dubbed SQUID purported itself as a way to play games inspired by the show.
From its opening trading day on 26 October 2021, the token’s price had reached a staggering $2862 by the start of November but eventually crashed in minutes.
The bad actors behind the scheme reportedly pocketed about $3.4 million. This event was a classic case of an ‘exit scam’ in DeFi (decentralized finance).
While the DeFi industry has been booming over the last few years, it hasn’t been without controversy. This has left investors having to think twice when observing any potential investment.
So, what is a rug pull in crypto?
A rug pull (or exit scam) is the loose equivalent of a pump-and-dump scheme. Here, a developer behind a recently-listed token unexpectedly abandons the project and runs away with investors’ money.
Due to advancements in blockchain technology, it has become much easier nowadays for the average Joe to create their own cryptocurrency and have millions of funds poured into it.
The modus operandi involves listing a token on a decentralized exchange (DEX), as these platforms perform fewer verification checks than centralized exchanges.
Then, the criminals set up a liquidity pool on a DEX by pairing the new token with another cryptocurrency like Ethereum (ETH) or Binance Coin (BNB).
Funds are generally locked in that liquidity pool for a prescribed period. Similar to a pump-and-dump scheme, the developers promote the token with overblown value propositions, attracting even more investors.
Of course, this increases the value of the coin. At some point, the developers will eventually withdraw all the ETH or BNB from the pool, making the token worthless as it tanks in price.
Moreover, investors will not be able to trade this crypto back to the ETH or BNB.
Tell-tale signs of a potential exit scam
Fortunately, with a bit of due diligence, rug pulls tend to exhibit one or a few of the following warnings:
Anonymous developers
Of course, many legit crypto projects exist with anonymous developers (yes, you Bitcoin). However, this rings more alarm bells for a new token. A bonafide project should have a team of well-known developers with a verifiable and clean history.
The project appeared overnight
Virtually all rug pulls are the result of low-effort, massively hyped projects. Often, they may be copycats of an existing cryptocurrency. An actual, investable project usually takes years to develop and will have a trail to verify how long it’s existed conceptually.
Therefore, one reliable identifying method is seeing when the project was conceived. If it seems like a recent idea, it’s probably too good to be true. Another sign to observe is the whitepaper length.
Compared to the tens of pages for established cryptocurrencies, a new cryptocurrency will have a paper only a few pages long.
Similarly, you should also check the social media presence. Scam cryptos will understandably have far fewer followers with barely any engagement. Sometimes, the website looks basic and has words like ‘launching soon’ or ‘work in progress.’
Ultimately, credibility in any digital currency boils down to time.
Low liquidity
Thanks to blockchains being publicly distributed, you can verify the liquidity of most coins. Liquidity refers to the ability to convert the token into another currency without causing an adverse reaction to its price.
We also use this metric to measure how valuable a cryptocurrency is. If a coin has lower liquidity, this can cause the value to depreciate at any given time drastically.
Established cryptocurrencies will have a 24-hour trading volume in the tens of millions of dollars, while it could be in the tens of thousands for less developed tokens.
A general rule of thumb is the volume over the last day should be at least 10–40% of the coin’s market cap (price multiplied by the total number of coins).
Disproportionate token ownership
A blockchain explorer like Etherscan can show you the token ownership and supply according to individual wallet addresses.
Generally, if you find a single wallet holds over 10% of the entire distribution, price manipulation can happen more easily, meaning you should be suspicious.
Lack of audits
Another solid verification method is seeing whether the project has been audited for security and financial transparency.
Although no law states a cryptocurrency must follow this procedure, it certainly lends credence and drastically decreases the chances of something fishy.
Final word
While DeFi has provided users with unimaginable freedom in moving and making money, the trade-off has been poorly enforced regulations leading to scams like rug pulls.
As they say, always DYOR (do your own research) in this industry to avoid being a victim of such incidents.
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