Illegal activities related to the cryptocurrency space broke new records last year with a soaring 79% increase and $14 billion in total losses. So-called Rug Pulls emerged as one of the most popular types of fraud with over $2.8 billion stolen from victims of DeFi protocols.
A Rug Pull can be quite difficult to detect but there are also tricks to detect and identify such malicious intentions.
So, if you are looking to learn how to identify a rug pull in crypto, keep reading.
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What is a Crypto Rug Pull
In simple terms a “rug pull” is a type of scam where the developers or token creators essentially run away with investors’ funds.
Usually this happens when scammers create a legitimate looking project, release a token based on a promising idea and register it on decentralized exchanges (DEX). When the value of the token increases, the scammers simply withdraw all the funds that have been allocated and quickly abandon the project.
Simply put, the “rug pull” is just a newer version of exit scams, which have been around in the cryptocurrency space since the beginning and increased especially during the ICO boom. Scammers also used to disappear with investors’ funds at the time, during or after the fake ICO, based on a promising idea.
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How a Crypto Rug Pull Happens
The popular place for scammers is decentralized exchanges (DEX) and liquidity pools, which play a critical role in DeFi.
DEXs do not require strict controls for newly listed tokens. Anyone can register their tokens and this is one of the reasons why they are an easy target for fraudsters.
Another reason is the decentralized nature of the liquidity protocols that act as market makers for DeFi. They do not have a centralized entity to facilitate trades, all buy and sell orders are determined and executed by smart contracts.
But for trading to be possible, liquidity must first be available. Liquidity is provided by a bunch of investors who lock up their funds in various pairs of cryptocurrencies.
Anyone can create a liquidity pool for new trading pairs by committing a certain amount of capital.
When a liquidity pool is created, the scammer entices investors with high returns to buy their tokens and locks them into the liquidity pool to generate returns.
It depends on the imagination of the scammers what tactics they use to attract victims. Extremely high returns are one of their usual tricks.
So, every time the token price increases, the scammers take out the entire amount locked in the liquidity pool.
Usually, they implement special code that disables the ability of investors to sell their tokens back to the exchange.
Meanwhile, the scammer is fully capable of doing whatever they want and exchanging those tokens for some other cryptocurrency.
How to Identify a Rug Pull in Crypto
Although common, Rug Pulls can be difficult to identify. The good thing is that investors have now become smarter and more educated to spot suspicious signs, but still many in the space don’t understand the risk.
Some signs so oh how to spot a rug pull in crypto.
1. Hype out of nowhere
One of the most common ways to identify s rug pull in crypto is that It should be a red flag for investors if a relatively new token suddenly appears all over social media and creates massive hype around it.
The hype is usually based on a token’s potential or impressive returns that seem “too good to be true”. Hype is a common tactic used by scammers to inflate the value of their token, which is actually fake and a hoax at best, or a scam at worst.
2. Breathtaking promises
Scammers need some bait to quickly lure in their victims. Their typical bait includes promises that are hard to resist.
A revolutionary narrative, extremely generous performance projections and guaranteed profits are the constant features of a Rug Pull. So if the promises sound too good to be true, it’s safer to stay away.
3. No code control
Tokens should undergo smart contract audits to ensure they are ready to function as a suitable investment tool.
An audit is designed to uncover any bugs or other security weaknesses in the code. Projects that have conducted a security audit always publish the audit reports to media channels and provide a link to the company that conducted the audit.
Cryptocurrency projects that do not share their code and ignore code-related security warnings should be treated with great caution.
4. Anonymous founders
The team behind each new project project is extremely important. If the project is correct and real and has no malicious plans in the pipeline, there is no reason for the founders to hide their identities.
An anonymous team means an inability to trace them in case something happens. It indicates a lack of responsibility and is considered a major red flag (i.e. a sign that the project needs attention).
5. Unclear Whitepaper
Fraudulent projects are not long-term, so fraudsters do not put much effort into them. You can see this from the fuzzy whitepaper, the key document of any project that includes its strategy, objectives and an analysis of the target market.
If the project doesn’t share its whitepaper or provides a very abstract that looks like a promotional material, it accordingly needs a lot of attention.
6. Unrealistic roadmap (roadmap)
A good project must demonstrate to investors its serious intentions and its ability to deliver its plans.
The roadmap of a project allows an assessment of its current achievements and future development plans.
If the roadmap is abstract or does not exist at all, the so-called Rug Pull may be the team’s only plan for the future.
Also, if the roadmap states unrealistic future development plans, but the project has not yet achieved anything significant, consider it another alarm.
7. Available only in DEX
Centralized cryptocurrency exchanges usually have strict listing policies and require new tokens to meet their requirements. This is also a fairly time-consuming process, so scammers don’t invest their time or capital and so mostly only import tokens to decentralized exchanges (DEX).
8. Unlocked liquidity
Most liquidity pools lock their digital assets for a certain period of time. This is a necessary step to give liquidity providers confidence and protect them from a potential Rug Pull.
If the pool remains unlocked, malicious developers may drain the assets and leave investors without their perishable assets.
9. Token distribution
Fraudsters tend to keep a huge portion of the token supply for themselves. If a large percentage of tokens are in the wallets of a few holders, there is at least the possibility of a rug pull or price manipulation.
Check the distribution of tokens on sites like Etherescan or BSCScan. If there are few holders but with huge amounts of tokens in their wallets, take this as a warning sign.
10. Low liquidity and trading volume
A healthy trading volume should be between 10% and 40% of the asset’s market capitalization.
A low 24-hour trading volume indicates low liquidity. If the trading volume is below the 10% threshold, it probably signals that there are not enough assets locked in the liquidity pool.
Do your research on why this is the case: perhaps the project is too new or liquidity is not locked in. Information about liquidity pools is usually available on the large and reputable DEXs.
Final thoughts
In summary, studying the fundamentals and doing your own research before investing is vital. It is the only way to remain critical and avoid falling victim to scammers.
One rule of thumb is that when in doubt follow your instincts. If you feel an urgent urge to buy just because your favorite YouTuber promoted a token, it’s always best to wait. Give yourself at least a few days or a week to research and observe its price movements.
Digital currencies are less regulated than other investment assets such as stocks, real estate or commodities. This means, scammers will also remain part of this space.
Furthermore, with the growing adoption of cryptocurrencies, we may see an increase in cryptocurrency theft in the coming years. Therefore, we must remain vigilant.
