With new projects and technologies emerging every day in the crypto space, investors are attracted by the possibility of making huge returns with relative ease. However, just as the sector promises quick profits, it is also full of pitfalls.
Today we’re going to tell you about a common scam that you may have only heard of by name: the Rug Pull. This fraud, as the name suggests, is a “rug pull” on investors, leaving them with significant losses.
In this article, we’ll look at what a rug pull is, how to identify it, and what steps investors can take to protect their investments. We’ll also discuss how to choose exchanges that address this issue.
What is Rug Pull?
A rug pull is a scam in which the developers of a cryptocurrency or token project create an environment of false security to attract investors, and then 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 (DEXs), where tokens can be created and traded more easily and with less regulation. These exchanges differ from centralized exchanges in one fundamental way: in centralized exchanges, you can access the management structure in place, at least ask questions, because there is a company doing the work (and not a group of people who have no legal relationship with each other).
Rug Pull occurs mainly in decentralized finance (DeFi) projects and is often associated with tokens in the pre-launch phase or with low liquidity. And how it works is simple: as soon as the price of the token starts to rise and ends up attracting more investors, the project creators quickly withdraw their funds, sell all their holdings and leave the project bankrupt. This causes the price of the token to fall drastically, harming those who still had investments there.
Is it possible to identify a Rug Pull?
While many rug pulls may seem legitimate at first glance, there are telltale signs that can help you spot suspicious projects. Here are a few key things to look out for:
1. Blocked or missing liquidity
When we talk about the crypto space, liquidity refers to the ease with which an asset can be bought or sold without causing major changes in its price. Many reputable projects lock up a portion of their liquidity for a set period of time (i.e., they keep the assets “frozen” for those who invested) to ensure that investors can trade the token safely.
If a project has no locked 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 with no way to redeem their tokens. Before investing, make sure the project has sufficient liquidity and that it is locked for a fixed period.
In a comparison with traditional financial markets, this point is analogous to the Central Bank's regulations on banks' reserve requirements: a part of all the money we deposit in a bank account serves as the bank's “backing” and one of the reasons is the same as here.
2. Project source code is hidden or inaccessible
Many tokens created 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, this is a clear sign that something is wrong.
Think about it: in the Bitcoin whitepaper itself we have the statement that it is more worthwhile for a programming mechanism to decide things than human action, as it is subject to the bias that we all have as humans; If a source code can be changed easily, this bias will become so evident that it will become a clear danger to anyone interested in that project to the point of leaving resources behind it.
There are tools available to analyze token contract code. Checking the transparency of the project is an important step in avoiding rug pulls.
3. Promises of exorbitant returns
This is a point that is true in practically all scams in the crypto universe, so much so that this is certainly not the first time that you have seen this point serving as a warning when it comes to crypto scams.
If a project is promising extremely high and guaranteed returns in a short amount of time, this is a clear red flag. In the financial market, whether traditional or crypto, guaranteed profits do not exist, especially at high percentages. Rug pull scams often use this tactic to quickly lure unsuspecting investors looking for quick returns.
Don't forget: in finance, past returns do not describe future prices; at most, they serve to explain the history of an asset. The market may be traditional or innovative, but this is always a reality.
4. Anonymous or non-transparent development team
Anonymity in the crypto universe is not uncommon, in fact it is one of the reasons that can attract users. In any case, this can 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 may indicate a higher risk. Scammers prefer to keep their identities secret to avoid legal repercussions after the rug pull is carried out.
Before investing, it’s always a good practice to research the founders and developers of the project. Make sure they have a reliable reputation and a solid track record. This may not completely prevent you from falling into a trap, but it can greatly reduce the risk of doing so.
5. Suspicious trading volume (with noticeable variation)
Be wary of drastically low or excessively high trading volumes in a very short period of time. Tokens that are experiencing abnormal growth may be being manipulated to create a false sense of security. This could be a rug pull tactic to inflate the price and encourage more people to buy before the developers abandon the project.
For these and other reasons, it is always worth looking at the price history of a token: not because it contains any information about future prices, but to understand some patterns that can help you identify any strange variations later on.
How to protect yourself against a Rug Pull?
This scam requires some care, but luckily for you, we have here to show you some measures you can take to reduce the chances of being a victim of a rug pull:
1. Do Your Own Research (DYOR)
Don’t blindly trust promises or what is being said on social media, influencers or forums. Research the project, the tokenomics (financial structure of the token), the team involved, the goals and the community behind the project in depth. Personal research is essential to avoid falling into traps.
2. Be wary of projects without auditing
Projects that have undergone security audits are more credible. Independent auditors check whether the smart contract code has vulnerabilities (like the one we discussed here) or loopholes that could allow for hacking. If the project hasn’t been audited, think twice before investing.
3. Monitor liquidity
Make sure the project has sufficient liquidity and that it 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 can be a great indication that the developers won’t disappear with the invested funds overnight.
4. Avoid investing large amounts in newly launched tokens
Newly minted tokens, especially on decentralized exchanges, can be extremely volatile and risky. Consider investing a small amount initially until the project proves itself legitimate and trustworthy.
This rule is almost the same as what you usually hear about new cars: wait for people to buy and talk about their experience, this is part of what good research can do in terms of reducing risk.
5. Choose reliable exchanges
Investing in reputable exchanges like Binance can be an effective way to protect yourself. These exchanges often have strict security measures in place, and many of them rigorously vet the projects they list, minimizing the risk of rug pulls.
How do you know if an exchange handles rug pulls well?
Investors can choose exchanges that adopt strict practices for listing new tokens and, ultimately, this can reduce the risk of operations, because centralized exchanges have teams dedicated to those who invest in them.
Trustworthy exchanges have robust listing criteria, which include security audits, compliance checks, and liquidity analysis. In plain English, this means that they don't just put any project on their shelf.
These measures protect users from scams like rug pulls. Additionally, these platforms frequently alert users about high-risk projects, keeping their investors informed and safer.
Before investing in a project, it is also worth checking whether it is on the exchange you already invest in and trust. If it is not, do more research or give up on making that investment.
To avoid rug pull, don't forget safety!
Rug pulls represent one of the biggest risks in the cryptocurrency world, and it's essential that investors are aware of the warning signs. By doing your own research, being wary of exaggerated promises, and choosing reputable exchanges, you can significantly reduce your chances of falling for this type of scam.
After all, investing safely is the key to navigating the crypto world without any scares - which, contrary to what people who are unfamiliar with this market might suggest, is indeed possible.
Do you know anyone who has been through a situation like this? Tell us!
