Every investor’s worst nightmare is a token rug pull. How to prevent falling for fraud without feeling foolish? This article will provide clarification.
As with any flourishing business, the decentralized finance (DeFi) and cryptocurrency space has attracted its share of scammers and unscrupulous actors looking to dupe investors into phony schemes dubbed rug pulls – only to steal their money.
However, this does not exclude investors from avoiding rug pulls and hoaxes through a disciplined investment mindset and thorough diligence. Crypto veterans frequently advise people to DYOR — do your own research — but what does that actually entail, and what should one do to avoid becoming a victim of fraud? What are the telltale symptoms of rug pulls and how can you identify the perpetrators?
We’ll discuss some of the most significant red signs in cryptocurrency projects and how to avoid them, so you can survive the next Squid Game rug pull with your wealth and dignity intact. This will delve into the following topics:
What is a rug pull and what causes it?
A developer establishes a cryptocurrency or decentralized financial infrastructure initiative and invites investors. Once investors have committed sufficient funds to the project, a dishonest developer may cash out and abandon it. This is referred to as a rug pull.
These are typically low-effort initiatives managed by nasty individuals and put together in a matter of days. They are occasionally slightly modified clones of other cryptocurrencies.
Let’s begin by examining the three primary forms of rug pulls and how they occur.
Liquidity theft
To make a cryptocurrency tradeable, developers must establish a liquidity pool that holds a sufficient quantity of the currency to enable investors to purchase and sell. The developer constructed a liquidity pool using his newly created scam token and a legitimate cryptocurrency, such as Ether, in the majority of reported rug pulls.
As more and more people become convinced of the fake cryptocurrency’s value proposition, they begin purchasing it in exchange for their ETH, which is locked up in the liquidity pool for a specified length of time. As more investors purchase the fictitious token and its value increases, a growing amount of ETH is pumped into the liquidity pool.
The malicious developer will withdraw the ETH from the liquidity pool at his leisure, leaving behind the worthless token. Investors are unable to repurchase their now-worthless tokens, while the developer withdraws his funds in legitimate ETH and flees.
Disabling the sale of tokens
The end consequence of this fraud is identical to that of liquidity theft discussed previously, but the process is different. The inventor of this fraud installs a piece of code that prevents investors from selling their coins back to the exchange.
To summarize, investors can purchase the fake coin, but due to the bogus piece of code, only the developer can sell his coins. When the price reaches a point where people attempt to cash in and sell their coins, they will discover that they are unable to do so. At some point, the scammer will determine that the price is sufficiently high, and he will sell all of his scam tokens, escaping with the value of the investments.
Developers reaping the benefits
While this does not sound like a scam in a free market, it is if the project is developed solely for this purpose. As with the previous two frauds, the malevolent developer builds an inflated value proposition for the project. Typically, the promise pertains to a particular feature or platform that is currently in development and will be deployed shortly.
However, in practice, the developer just mints a useless token, giving himself a substantial portion of these tokens from the start or purchasing them cheaply on the market. As investors flock to the worthless token due to the innovative product’s promise and the price skyrockets, the creator will cash out his shares. He can do this all at once or gradually, making the rug pull less visible. In either case, investors are left with a useless token and their investment cash is wiped out.
Typical indications of a rug pull
The initiative materialized out of nowhere.
Rug pulls typically appear out of nowhere, but legitimate cryptocurrency or decentralized financial infrastructure projects take years to build. These fictitious initiatives are frequently accompanied by a great deal of hype, leveraging on famous cultural memes. If a project claiming to alter the crypto world appears overnight and appears to be too good to be true, it almost certainly is.
Developers who remain anonymous
While Bitcoin, the first and largest cryptocurrency, was created by an anonymous developer known as Satoshi Nakamoto, the presence of anonymous developers on a crypto or DeFi project should raise a red warning that something is wrong. Today’s most successful cryptos, including as Ethereum and Solana, are fueled by a team of well-known leaders. If the developers of a cryptocurrency or DeFi project wish to stay anonymous and avoid association with it, they may have valid legal reasons for doing so, and you should most likely avoid that token.
Low liquidity
While it is not always possible to check the liquidity of DeFi initiatives, it is always possible with a cryptocurrency. Low liquidity indicates that it is difficult to convert the token to cash, which could be the result of the developer having a limited budget to build the token. The less liquidity a coin has, the easier it is for the developer to manipulate its price.
The best technique to determine a cryptocurrency’s liquidity is to examine its 24-hour trading volume. Scam tokens have developed with a trading volume of as little as US$10,000, compared to a true decentralized platform like PancakeSwap, which has a trading volume of US$301 million at the time of writing. Veteran crypto investors use a basic rule of thumb that trading volume should be between 10% and 40% of the coin’s total market capitalization.
Liquidity obtained
To foster trust and bolster public impressions of their validity, prominent cryptocurrency creators frequently relinquish control of the liquidity pool by enclosing it within their blockchain or entrusting it to a trustworthy third party. This is referred as locked liquidity, because it stops developers from transacting any of the pool’s tokens, making it difficult to steal tokens or significantly diminish liquidity. The longer the pool is locked up, the less likely a rug will be pulled.
On the other side, if the liquidity is not restricted, nothing prevents developers from withdrawing it and fleeing. However, determining if the liquidity is locked is a relatively complicated operation.
‘Total value locked’ is set to a low value (TVL)
TVL is another reliable metric for determining a cryptocurrency’s or DeFi project’s authenticity. This is the overall investment made in a certain project. PancakeSwap, for example, has US$ 14 billion in TVL, whereas scam projects may have only a few thousand dollars. The more recent the project and the lower the TVL, the greater the likelihood of a rug pull.
Disproportionate distribution of tokens
By examining a project’s token distribution on services such as Etherscan, you may determine who possesses the most tokens and how they are dispersed. If a single or two wallets hold a significant portion of the token supply — 5% or more – selling all at once is simple, increasing the danger of price manipulation or a rug pull. Thus, the more evenly dispersed the token supply, the safer the cryptocurrency is to invest in.
Website with little effort and no social media presence
Scam tokens frequently have a simple, low-effort website that was copied or whipped up in a matter of days. Several of these phony enterprises have websites that state they are “in construction” or “coming soon.” Additionally, many initiatives will lack social media presence or may have a small following. If a cryptocurrency or DeFi project’s social media accounts are devoid of actual community involvement, this should also serve as a huge warning flag to investors.
This also applies to the white paper for a project. Scam initiatives occasionally include a white paper that is either copied from another source or is extremely brief. Ethereum’s whitepaper is 36 pages long, while Solana’s is 32 pages long. If a cryptocurrency appears overnight and has a significantly shorter white paper, this is a red flag that the project is not legitimate.
no audits.
Independent security assessments or financial transparency reports attesting to the authenticity of the most significant cryptocurrency projects will be available. For example, Cardano’s security has been strengthened by many audits and an independent source code audit. Without a third-party audit, a project is not always fraudulent, but it does suggest that you should conduct an extensive investigation before investing.
The best way to avoid rug pulls
Now that you’re aware of the most telling indicators of a rug pull, let’s break down some of the best methods for conducting crypto research in order to avoid falling victim to such scams.
There are several internet programs that can assist in detecting a rug pull, one of which is Token Sniffer. To begin, Token Sniffer keeps track of all the current hacks and scam coins, so if you come across a project on its list, you can be certain it’s a rug pull.
Second, the site provides an automatic audit of tokens, examining their smart contracts, liquidity, and degree of similarity to other projects, and assigning each token a risk score.
Another excellent tool for discovering exit frauds is Rug Doctor. The site analyzes the source code of cryptocurrency projects in an attempt to discover the most often used rug-pull tactics. Once Rug Doctor identifies a high-risk coin or DeFi project, it publishes it on its website, complete with a risk assessment and a breakdown of the project’s red flags.
Finally, a blockchain explorer such as Etherscan or Binance Smart Chain explorer is required for a high level of scam detection. When you search for a cryptocurrency’s token address, a Token Tracker Page will display, typically under the More Info section. The tracker will display the total supply, the total number of holders, and the total number of transactions, and you should be able to click on Holders to view the wallets holding the most tokens.
If the top ten wallets possess more than 20% of a new cryptocurrency, or worse, if a big amount of the token is held in a single wallet, this is a warning indication of a future rug pull. If one or more of these prominent wallets sells all of their tokens in an exit scam, the cryptocurrency’s price will plummet.
Notable rug pulls throughout crypto history
Bear in mind that the names of these scams may be confusingly similar to those of actual cryptocurrencies.
OneCoin
OneCoin was essentially a massive Ponzi scheme that is now considered as the largest cryptocurrency scam to date, having defrauded investors of an estimated US$25 billion. While authorities cracked down on OneCoin in 2017 and jailed its officials, several of its founders vanished and the scam continues. And the worst part is that this Ponzi scheme was never even associated with a cryptocurrency.
BitConnect
BitConnect stole an estimated US$2 billion in another multi-level, marketing-driven Ponzi scheme. To entice investors, the hoax project claimed to have an unmatched trading algorithm. Additionally, after the project’s initial coin offering (ICO) failed in January 2018, its founders created BitConnectX – a second ICO rug pull.
Network of BitClub
BitClub Network was the largest crypto-mining Ponzi scheme to date, attracting funds through the use of bogus advocates and demanding marketing practices. The value offer was that investors would get guaranteed returns on their Bitcoin mining activities, but footage of their mining machines was later discovered to have been stolen from another company. In December 2019, the scam’s founders stole an estimated US$722 million from investors.
Squid Game Token
The Squid Game token was a high-profile rug draw that took advantage of the buzz around the blockbuster Netflix series “Squid Game.” In less than two weeks, the SQUID token’s price increased by more than 230,000 percent, and investors’ ability to sell the token was disabled. On Nov. 1, 2021, the creators withdrew an estimated US$3.4 million from investors after the token fell from US$2,861 to US$0.01 in less than five minutes.
In conclusion
As the blockchain business grows in size, rug pulls in bitcoin and DeFi are becoming more prevalent, while frauds have begun to plague the NFT space. However, by conducting a thorough study and looking for evident warning indicators, investors can avoid them.
Leave a Reply