With new projects and technologies appearing every day in the crypto universe, investors are attracted by the possibility of earning high returns with relative ease. However, just as the industry offers promises of quick profits, it is also full of pitfalls.
Today we are going to talk about a common movement, but one that you may have only heard of by its name: the Rug Pull. This scam, as its name suggests, is a “rug pull” by investors, which leaves them with significant losses.
In this article, we will understand what a rug pull is, how to identify it, and what steps investors can take to protect themselves. In addition, we will discuss how to choose exchanges that address this issue.
What is a Rug Pull?
Rug Pull is a scam in which the developers of a cryptocurrency project or token create a false sense of security to attract investors and, at a certain point, suddenly withdraw all funds, leaving investors empty-handed.
This scam is very common in new and decentralized projects, such as those offered on decentralized exchanges (DEX), where tokens can be created and traded in a simpler way and with less regulation. These exchanges differ from centralized ones in one fundamental aspect: in centralized ones, you can access the management structure carried out, or at least clarify doubts about it, because there is a company doing this action (and not a group of people who have no legal relationship with each other).
Rug Pull occurs primarily in decentralized finance (DeFi) projects and is often associated with pre-launch or low-liquidity tokens. And how it works is simple: as soon as the token price starts to rise and eventually attracts more investors, the project creators quickly withdraw their funds, sell all their holdings, and bankrupt the project. This causes the token price to drop dramatically, harming those who still had investments there.
Is it possible to identify a Rug Pull?
While many attacks may appear legitimate at first glance, there are signs that can help identify suspicious projects. Here are some key points to look out for:
1. Blocked or missing liquidity
When we talk about the crypto universe, liquidity refers to the ease with which an asset can be bought or sold without causing major swings in its price. Many reliable projects lock up some of the liquidity for a certain period (i.e. they keep the assets of those who invested “frozen”), to ensure that investors can safely trade the token.
If a project does not have secured liquidity or the liquidity is extremely low, this could be a warning sign.
If liquidity is not locked, developers can withdraw all funds at any time, leaving investors without the ability to redeem their tokens. Before investing, check whether the project has sufficient liquidity and whether it is locked for a certain period.
Compared to traditional financial markets, this point is analogous to the Central Bank's regulations on bank reserves: a portion of all the money we deposit in a bank account serves as "backing" for the bank.
2. The project source code is hidden or inaccessible
Many tokens built on platforms like Ethereum or Binance Smart Chain are based on smart contracts. If the smart contract code is not public or has features that allow developers to quickly change the rules of the game, such as the ability to manipulate the token supply or modify transaction fees, it is a clear sign that something is amiss.
Think about it: in the Bitcoin whitepaper itself we have the statement that it is more worthwhile to have a programming mechanism decide things than human action, since it is subject to the bias that we all have as humans; if a source code can be easily changed, this bias will become so evident that it will become a clear danger for anyone interested in that project.
3. Promises of exorbitant returns
This is a sure point in virtually every scam in the crypto universe, so much so that this is certainly not the first time you see this point serving as a warning when it comes to crypto scams.
If a project promises extremely high and guaranteed returns in a short period of time, this is an explicit red flag. In the financial market, whether traditional or crypto, there are no guaranteed profits, especially at high percentages. Carpet-pulling scams often use this tactic to quickly lure in unsuspecting investors looking for quick returns.
Don't forget: in finance, past performance does not describe future prices at all, it serves to explain the history of an asset; the market may be traditional or innovative, but this is always a reality.
4. Anonymous or opaque development team
Anonymity in the crypto universe is not uncommon, in fact it is even one of the reasons that can attract users. In any case, this could become a reason for caution when we talk about new token projects.
If the team behind the project is not identifiable or does not have a clear and established presence in the market, this could indicate a higher risk. Scammers prefer to keep their identities secret to avoid legal repercussions after the theft is carried out.
Before investing, it is always a good practice to research the founders and developers of the project. Make sure they have a trustworthy reputation and a solid track record. This may not completely prevent you from falling into a trap, but it greatly reduces the risks.
5. Suspicious trading volume (with a noticeable variation)
Be wary of drastically low or excessively high trading volumes in a very short period of time. Tokens that show abnormal growth may be being manipulated to create a false sense of security. This could be a tactic to inflate the price and encourage more people to buy in before the developers abandon the project.
For these and other reasons, it is always worth looking at a token's price history: not because it contains information about future prices, but to understand some patterns that can help you identify strange variations later on.
How to protect yourself against a Rug Pull?
This scam requires some caution, but luckily we have some steps you can take to reduce your chances of falling victim to a rug pull:
1. Do Your Own Research (DYOR)
Don't blindly trust promises or what is said on social media, influencers or forums. Do deep research on the project, the tokenomics (financial structure of the token), the team involved, the goals and the community behind the project. Personal research is essential to avoid falling into traps.
2. Beware of unaudited projects
Projects that have undergone security audits have greater credibility. Independent auditors check the smart contract code for vulnerabilities (like the one we discussed here) or loopholes that allow scams. If the project has not been audited, think twice before investing.
3. Monitor liquidity
Make sure the project has enough liquidity and is locked for a significant period of time. A good practice is to only invest in projects that have liquidity locked for months or years rather than days or weeks. This could be a big indication that the developers won't disappear with the invested resources overnight.
4. Avoid investing large amounts in newly launched tokens
Newly created tokens, especially on decentralized exchanges, can be extremely volatile and risky. Consider investing a small amount initially until the project proves itself to be legitimate and trustworthy.
This rule is much the same as what you often hear about new cars: wait for people to buy them and talk about their experience, this is part of what good research can do in terms of risk reduction.
5. Choose reliable exchanges
Investing in reputable exchanges like Binance can be an effective way to protect yourself. These exchanges tend to have strict security measures, and many of them rigorously vet the projects they list, minimizing the risk of scams.
How do you know if you are on a reliable exchange?
Investors can choose exchanges that adopt strict practices for listing new tokens, and this can ultimately reduce the risk of trading because centralized exchanges have dedicated teams for those who invest in them.
Reliable exchanges have robust listing criteria, including security audits, compliance checks, and liquidity analysis. In simple terms, this means they don't keep any projects on their shelf.
These measures protect users from scams such as rug pulls. Additionally, these platforms often warn users about high-risk projects, keeping their investors informed and safer.
Before investing in a project, it is also worth checking if it is on the exchange you already invest in and trust. If not, do more research or give up on making this investment.
To avoid pulling on the carpet, don't forget about safety!
Rug pulls represent one of the biggest risks in the cryptocurrency world, and it is essential for investors to pay attention to the warning signs. By doing your own research, being wary of exaggerated promises, and choosing trustworthy exchanges, you can significantly reduce the chances of falling for this type of scam.
After all, investing safely is the key to navigating the world of cryptocurrencies without fear – which, contrary to what people unfamiliar with the market might suggest, is indeed possible.
Do you know anyone who has been through a situation like this? Tell us!