What is a 'rug pull' in cryptocurrency?
A 'rug pull' scheme occurs when a team or developer abandons a project, leaving investors with worthless tokens.
Imagine you are at a party where you find an exciting game. Players are having fun and there are great prizes. You decide to join, invest money, and start playing. However, just as you are about to win, the game organizer disappears with all the participants' money.
This is exactly what happens during a 'rug pull' in cryptocurrency.
Cryptocurrency scams are prevalent in the decentralized finance (DeFi) space due to the lack of regulations to oversee project operations. Individuals or groups of developers create hype around a crypto project to attract traders. With growing interest, many people invest by purchasing tokens or minting non-fungible tokens (NFTs).
Then the developers suddenly sell their assets and disappear, leaving investors shocked and empty-handed. The sudden termination of the project leads to a sharp decline in the price of its token, causing investors to lose most of their money.#Rugpull
How to detect a 'rug pull'
In the thrilling yet risky world of cryptocurrencies, the term 'rug pull' raises alarm even among the most experienced investors. However, by understanding the essence of a 'rug pull' in blockchain, one can spot red flags early on.
If you know the signs of a crypto 'rug pull,' you will be able to identify potential scams before it's too late. From verifying the project team to analyzing the tokenomics and engaging the community — these are key steps to spot red flags and make informed investment decisions. Being aware of 'rug pull' signs will help you avoid scams.
Unknown or unidentified developers
Investigate the reputation and integrity of the individuals behind new cryptocurrency projects. Find out if they are well-known in the crypto space. Assess their past achievements and ability to meet commitments to understand how effectively they will handle 'rug pull' risks. Beware of fake social media and accounts. The quality of the project's website, whitepaper, and other media can also indicate its legitimacy.
Lack of locked liquidity
You can distinguish a reliable cryptocurrency from a fraudulent one by checking if its liquidity is locked. Locked liquidity means a mechanism where a certain amount of crypto tokens is held in a smart contract for a specified period.
If the liquidity is not locked, the project's creators can withdraw all the liquidity at any moment. Liquidity can be protected using time-locked smart contracts, ideally for three to five years after the token's release.
Restrictions on sell orders
The code may prohibit some investors from selling, while others may commit fraud. You can check this by buying a small amount of the new coin and trying to sell it immediately. If you cannot sell the tokens, it's a red flag that the project is fraudulent.
Sharp price fluctuations with a limited number of token holders
Be cautious of sharp price movements in new coins, especially without locked liquidity. Scammer cryptocurrencies tend to experience significant price spikes before crashing. Use a block explorer to determine the total number of token holders. If a limited number of users own the cryptocurrency, the token is more susceptible to price manipulation.
Suspiciously high returns
If it sounds too good to be true, it usually is. A new currency promising unusually high returns could be a Ponzi scheme if it's not a 'rug pull.' While this isn't always a sign of fraud, tokens with three-digit annual percentage yields (APY) are typically associated with high risk.
Lack of external audit
Check whether the cryptocurrency you plan to invest in has undergone a thorough code audit by a reliable third party. Potential investors should not just take the developers' word for it when they claim that an audit has been conducted. Instead, they should investigate who the auditor is and how trustworthy they are.
Examples of crypto 'rug pulls'
'Rug pulls' are meticulously planned by malicious actors who utilize influencers on social media and create hype to trick as many people as possible into investing.
Here are a few notable examples to help you understand how these scams work:
OneCoin
Ruja Ignatova, known as the crypto queen, co-founded OneCoin in 2014, positioning it as a revolutionary cryptocurrency. It later turned out to be a fraudulent Ponzi scheme that stole billions from investors worldwide.
In 2017, the crypto queen vanished, evading law enforcement. Her whereabouts remain a mystery. OneCoin is one of the largest crypto scams in history.
Squid Game#squidgame
In 2021, the Squid Game project was launched, inspired by the popular South Korean Netflix series 'Squid Game.' Promoters presented Squid Coin, the project's native token, as exclusive access to the 'play-to-earn' (P2E) game.
The hype was building, and the token's value surged rapidly. However, the project developers suddenly vanished after cashing out their tokens, leaving investors with nothing. The token price plummeted almost to zero.
AnubisDAO#AnubisDAO
AnubisDAO, a decentralized autonomous organization (DAO), promised investors significant returns and raised nearly $60 million within hours of its launch. However, the project's liquidity quickly vanished as the developers ran away with the investors' money.
The community was disheartened as the project's social media accounts were deleted, and the website became inaccessible, revealing a 'rug pull.'
How 'rug pulls' work in cryptocurrency
In the world of cryptocurrencies, a 'rug pull' resembles a seller at a bustling market who sets up an enticing stall but runs away with the buyers' money, leaving them with empty promises.
Imagine a crowded market where vendors sell various goods. A 'rug pull' is like a seller who sets up an impressive stall, attracting buyers with promises of valuable goods. The seller takes pre-orders for these goods at high prices. When the market is filled with hype, the seller suddenly disappears, leaving behind an empty stall and worthless booking receipts.
In the context of cryptocurrencies, the seller can perpetrate this fraud in several ways. One way is when fraudulent developers insert hidden loopholes into the smart contract to control the native token or steal cryptocurrency from investors. In such a 'rug pull' scheme, the developers' malicious intent is evident from the start.
Secondly, developers may employ a technique known as 'dumping.' This involves scammers quickly selling their cryptocurrency assets. This action sharply decreases the value of other investors' tokens, resulting in losses. In cryptocurrency, 'pump and dump' schemes refer to market manipulation where scammers deliberately inflate the price of a digital asset ('pump') and then sell their assets at a high price ('dump'). This action results in significant losses for other investors.
Thirdly, scammers can execute a 'rug pull' by limiting sell orders. They restrict the sale of tokens for everyone except a few specific addresses. This allows the scammers to sell their tokens at will, while ordinary token holders cannot sell, ultimately rendering their assets worthless.
Is a crypto 'rug pull' illegal?
Laws around the world are increasingly targeting crypto 'rug pulls,' classifying them as fraud, theft, or violations of securities legislation.
Most jurisdictions around the world consider crypto 'rug pulls' illegal. Regulatory bodies across the globe are actively combating crypto 'rug pulls,' including the U.S. Securities and Exchange Commission and the U.K. Financial Conduct Authority (FCA).
Individuals involved in 'rug pulls' can face hefty fines, asset confiscation, and prison sentences. Despite the penalties, the decentralized and often anonymous nature of cryptocurrency transactions poses significant challenges for law enforcement. Victims of 'rug pulls' often have limited legal recourse due to unidentified developers and the cross-border nature of digital assets.
Despite these challenges, efforts to improve the legal framework for regulating cryptocurrencies continue. In May 2023, the European Union introduced the world's first comprehensive cryptocurrency regulations known as the Markets in Crypto-Assets Regulation (MiCA), aimed at overseeing and protecting crypto markets. As legislators' understanding of cryptocurrencies deepens, regulations in other parts of the world are also expected to improve.