The “pulling the rug out” fraud includes a developer luring investors to a new cryptocurrency project, then withdrawing before the project is completed, leaving investors with worthless currency. It belongs to a long line of investment strategies.

Rug pulls have been particularly popular in efforts aimed at disrupting businesses such as banking and insurance through decentralized finance, or DeFi. Rug pulls have also included NFTs, or non-fungible tokens, which grant digital ownership of paintings and other assets.

This post will explain the rug pull scam in detail and show you how to prevent it in the cryptocurrency market.

What is a rug pull scam?

Rug pull is a cryptocurrency fraud in which crypto developers and founders abandon a project and steal investors’ funds. Rug pull scams are common in the Defi ecosystem, particularly on DEXs.

Without any audit, malicious persons produce a token and list it on a DEX. They then establish a liquidity pool for it. The pool includes a pair of fraudsters tokens as well as a popular cryptocurrency such as Ethereum. Following that, once investors have exchanged their ETH for the new token or currency. Scammers drain the liquidity pool by withdrawing everything. As a result, the coin’s value falls to zero, and investors are left with a nearly useless token.

Rug pulls thrive on DEXs because they allow users to list token-free and audit-free. Anyone can quickly and for free generate a token using open-source blockchains like Ethereum. These explanatory factors, when combined, offer an ideal environment for unscrupulous persons to carry out a rug pull scam.

Types of rug pull

In cryptocurrency, there are 3 different types of rug pulls: liquidity stealing, limiting sell orders, and dumping.

Liquidity stealing

When token creators remove all coins from the liquidity pool, this is referred to as liquidity stealing. This destroys all the value that investors have infused into the currency, driving its price to zero.

These “liquidity pulls” are most common in DeFi situations. The most typical exit scam is a DeFi rug pull.

Limiting sell orders

Limiting sell orders is a devious way for a dishonest developer to defraud investors. In this case, the developer codes the tokens so that they are the only ones who can sell them.

Developers then wait for retail investors to invest in their new cryptocurrency using matched currencies. Matched currencies are two currencies that have been paired for trading purposes, with one being traded against the other. When there is enough positive price action, they exit their positions, leaving behind a worthless token.

Dumping

Dumping occurs when developers sell their own huge number of tokens quickly. This reduces the value of the coin and leaves the remaining investors with worthless tokens. Dumping occurs commonly after extensive advertising on social media networks. A Pump-and-Dump Scheme is the subsequent price increase and sell-off.

Dumping is more ethically ambiguous than other DeFi rug pull scams. It is not unethical for crypto developers to buy and sell their own currency in general. When it comes to DeFi cryptocurrency rug pulling, “dumping” refers to how much and how quickly a coin is dumped.

How to Spot Rug Pull Scams?

Here are several red flags of rug pull scams that you should be aware of in order to avoid rug pull scams in cryptocurrencies.

Low or No Team Credibility

Investigate the team’s legitimacy by looking into their track record, social media, work history, industry connections, and so on. You must also determine whether the token’s pool is locked. Most credible ventures secure pooled funds for a set length of time.

Ambiguous Cryptocurrency White Paper

If a protocol’s whitepaper is vague and opaque, it is generally a red flag for a rug pull scam. An external audit is a sign of the soundness of the smart contract, but not necessarily of the project’s soundness.

Unrealistic Return Projections

As with previous scams, if something appears to be too good to be true, it most likely is.

Only a few wallet holders and just listings on DEX platforms

Use a block explorer tool like Etherscan to confirm the amount of token holders. Check to see if it is listed and traded on other well-known exchanges. More information on the coin may be found by conducting a quick search on Coingecko.

Coin Skyrocketing in Price

A coin’s value rapidly increasing is an indication of a rug pull. A rug pull coin, for example, can go from 0 to 50X in 24 hours. This method is intended to generate FOMO, causing more individuals to invest in the coin.

Bottom line,

Rug pulls occur when dishonest developers create a new crypto token, inflate its price, and then extract as much money as possible from it before leaving it as its price falls to zero. Rug pulls are a sort of exit scam that takes advantage of decentralised financing (DeFi).

Thus, before investing, it is worthwhile to conduct research on new cryptos and conduct due diligence on a new project.