Rug Pulls―What They Are and How to Spot One
Cryptocurrency scams have been on the increase and stand shoulder-to-shoulder with the cryptocurrency adoption rate of the past year. A report released in March 2021 by the Federal Trade Commission shows that fraudulent activities in the cryptosphere have grown by over 1000% since October 2020. In contrast, the cryptocurrency adoption index during the same period is about 880%.
Lossless placed the above stats side-by-side revealing that the new adopters of blockchain technology are at an increased risk of falling for crypto scams. This is particularly because these rookies are looking for ways to make a quick buck and cash in on the latest soaring coin. A most recent example is the Squid coin that had an overnight growth of over 23 million percent and topped at a unit valuation of $2,861.80. The liquidity was pulled out, and the valuation ran down to zero―a classic pump and dump.
What is a Rug Pull?
Rug pull is a type of cryptocurrency scam where token creators make away with investors’ money. The developers create a token with a promised use case or utility, list it on a decentralized exchange (DEX), pair it with a reliable and valuable token to make it look legit, carry out aggressive market campaigns to exaggerate its benefits, pump its unit valuation by injecting liquidity, and pull out investors’ funds after attracting mass traction.
If the means of money theft is by sucking the liquidity pool dry and deserting the project, it is called a liquidity scam or soft rug pull. However, if a backdoor is exploited to drain funds locked in smart contracts, the rug pull is a hard rug pull or technical manipulation.
Decentralized Finance and Rug Pulls
Rug pull is becoming increasingly specific to the DeFi subsector. Ninety-nine percent of all fraud-related cases in the sector are rug pulls, according to CipherTrace’s 2020 year-end report. Its affinity for the DeFi space can be attributed to the underlying functions and features of smart contracts, which are being trustless and permissionless. And because the DeFi space is devoid of a central governing body that checks and balances the activities of both token creators and developers. For these reasons, anyone can create a token with the lifespan of a sneeze.
Rug pulls can hurt a budding sector like DeFi as its mantras (of trustless and permissionless transactions) are being threatened. And it may hurt and halt the mainstream success of blockchain technology altogether
How to Identify Rug Pulls
These days, the total monetary value stolen has decreased majorly because investors have grown wiser; thanks to blockchain education going mainstream. Notwithstanding, some developers still utilize some sophisticated tricks to prey on rookie investors’ FOMO mentality with subtle psychological marketing littered all over their documentation and marketing strategies. Knowing these tactics and more, Lossless shows you a few ways you can identify potential rug pulls.
Substandard documentation: You will probably never go wrong reading through the pitch deck, litepaper, and whitepaper. These documents should be able to answer your questions. If any of these documents seem hurriedly prepared with one too many errors as it was with $SQUID, we recommend you run the other way.
Anonymous developers: This is one of the hallmarks of a token with a rug pull in sight. Anonymity is often a clever play by developers to embody the virtues of blockchain. Some teams are anonymous and credible; others wear the invisibility cloak to make it easier to vanish with your money.
A sudden increase in valuation: Now this is sometimes a ploy by fraudsters to poke at investors’ FOMO psyche. Sudden increases are usually due to influencer marketing and buzz, and nothing genuine like groundbreaking decentralized exchange listing.
Unrealistic high yield percentages: If APYs and APRs are audacious; it could be genuine or not, but it is probably an attempt to draw investors searching for uncommon ROI. Take extra care when you come across such projects.
Flawed tokenomics model with a large percentage owned by developers: Coins with large central supply control are often scams, especially if the numbers on its whitepaper and pitch deck differ from actual token distribution. You can use Etherscan and BSCscan to check for distribution models if the coin is based on Ether and Binance Smart Chain, respectively.
Absence of use cases or the presence of unexplainable ones: Investors are beginning to become aware that use cases are one of the pointers to a token’s credibility. That said, scammers often promise use cases and conceal them with aggressive marketing campaigns to fool investors and achieve faux credibility status.
Inactive community and social media channels. If a community does not support querying or questioning the project, or if community members don’t get responses to their questions, the project is most likely a scam.
As far as we are concerned, the gulf in knowledge between the token creators and the public narrows by the minute. However, the sheer volume of tokens springing up, the shortening attention span, and careful planning have put these scammers at a great advantage. As such, it is advised that you do your research irrespective of the promise of fat investment returns. Before any transaction, be sure to remind yourself that blockchain is immutable and money lost is irretrievable. This is enough to jolt you back to reality and cause you to look out for the above red flags.
Having a rug unexpectedly pulled from beneath you isn’t a fun experience, even as a prank. Unless you were expecting the yank, chances are you may fall over. And if luck runs the other way, you may lose a tooth or two. But in this thing of ours when a rug is yanked from under you, you lose your investment and not your teeth. It is this loss that Lossless seeks to help you avert.