Crypto rug pulls are scams that can cause token prices to skyrocket and then plummet, leaving investors with huge losses. In this article, we will discuss what crypto rug pulls are with the help of fraud investigator Chris from The KYC Alliance. We will also explore how to avoid them so that you don't lose your hard-earned money.
What is a crypto rug pull?
A rug pull is when a developer or team generates hype for a project they create. Then, they abandon the project and take the money with them. This can happen for a number of reasons, such as financial difficulties, disagreements within the team, or simply because they never had any intention of completing the project in the first place. Whatever the reason, rug pulls are bad news for investors.
Rug pulls tend to happen with decentralized finance projects (DeFi). Furthermore, they are more notorious on Decentralized Exchanges (DEXs) since these do not require certain auditing processes that Centralized Exchanges would usually require (even though there are questionable centralized exchanges as well).
Unfortunately, rug pulls have been increasing in popularity. As noted in a previous article, Chainalysis reported that a record $2.8 billion, or 37% of all worldwide crypto scams in 2021, were stolen due to rug pulls.
Hard rug pull vs soft rug pull
A hard rug pull is when a project's team suddenly withdraws funds after garnering significant investment from their community. The three main types of hard rug pulls are dumping pulls, liquidity pulls, and limiting sell orders. On the other hand, founders who are interested in maintaining their cover can use a soft rug pull to dump only some tokens, rather than all of them. This technique maintains the pretense that you're invested while still supporting your community.
Common ways a project hard rugs:
- Liquidity is not locked, and devs remove it all. This drops the price by 99.9%, and essentially makes the token unsellable by investors.
- The contract contains a function that allows devs to ban wallets from selling, or a function that allows them to set sale taxes to 100%, making the token impossible to sell. This method is known as a honeypot.
- The contract contains a mint function, which the devs use to rapidly mint and sell billions of tokens at once, effectively draining the liquidity pool through sales. Notably, this method works with locked liquidity, since it only involves selling freshly minted tokens on the open market.
Are crypto rug pulls illegal?
Rug pulls are something fairly new to the age-old criminal finance world, but that doesn’t mean they’re not punishable. In some cases, rugging investors can also lead to criminal charges being filed against you.
Here is a video expanding on what a rug pull is:
Which crypto projects have been rug pulled?
One of the easiest ways to see whether a coin has been rug pulled in the past is by looking at their charts, which have a very unique shape (and can be heartbreaking if you're an investor). It would look something like this:
Here is a list of crypto rug pulls:
- Squid Game ($SQUID)
- Snowdog ($SDOG)
- Mercenary ($MGOLD)
Case study: What Happened with Squid Game Token (SQUID)?
Squid Game was one of the most notable rug pulls in the crypto world. The project built hype on the popular Netflix show Squid Game before the rug was pulled and the developers disappeared with the money. Some people captured the harrowing moment the token went down 99% in the span of a few seconds. The anonymous creators and developers of Squid Game coin sold their entire holdings rapidly.
In this case, the holder could buy the coin but had no option to sell it. It had all the means to fool users into thinking that it was a legitimate project, including a whitepaper. It is becoming more and more difficult to analyze whether a token is a rug pull or not.
How to spot a rug pull?
The best way to avoid crypto rug pulls is to do your own research (DYOR) before investing in any project. Chris from The KYC Alliance had his own say on this. In a previous AMA, Chris explained briefly what it takes to spot a rug pull or safe project to invest in. “A project’s fundamentals, tokenomics, if it had seed round funding and an unlocking schedule” are all things one needs to keep an eye out for, he had said.
“Generally speaking, when determining if a project will rug pull, you need to answer two basic questions: ‘can they?’ and ‘will they?’,” he said. ‘Can they?’ is “the easier of the two”.
“It’s a black and white, quantitative question that most automated contract scanners would be able to answer. If contract ownership is not renounced, and the contract contains functions that allow devs to mint, ban-list wallets from selling, or change transaction taxes without limits, then they can rug the project if they want to. Likewise, if the liquidity for a project isn’t locked (or not locked for a substantial amount of time), then devs could pull it whenever they want,” he remarked.
On the other hand, ‘will they’ rug pull a project is a “trickier question to answer”, he said. “It’s a qualitative question around human behavior, so there are no absolutes.”
There are a few key things you should look for which will tell you how to identify a rug pull.
- A well-developed website: If a project doesn’t have a professional-looking website, it’s a red flag. The website (if it exists) could also have lots of non-working buttons/features. Nonetheless, a well-developed website alone definitely does not mean that it's a safe project to invest in.
- A well-defined roadmap: This will give you an idea of what the team plans to achieve and by when.
- A solid and experienced team: rug pulls are often carried out by inexperienced or unscrupulous developers. Look for a team with a proven track record in the industry.
- A solid business model: Make sure there is a clear reason why the project needs blockchain technology and that there is a viable business model behind it. If you can't find any information on this, be very wary.
- A working product: If there is no working product, be wary. It could mean that the team is not as far along as they claim to be, or that they never had any intention of delivering on their promises.
- Pool liquidity: Check if there is high pool liquidity, how much of it is locked, and how long the liquidity is locked for.
- Unrealistic yields: If a project promises yields that are too high and unsustainable, it is quite likely that it is a questionable project.
- The project’s socials were very recently created: They already have thousands of followers, but minimal engagement (very few likes/retweets, same 2-3 people doing all the chatting on TG, etc).
- Presale starting rapidly: The presale would start shortly after social media accounts go live.
- Suspicious caps: Presale with very low soft cap, and high or unlimited hard cap (ex: 1BNB/500BNB)
- Shills and roadmap that way overpromise: For example token launches, NFT collections, P2E games, metaverse, and staking vaults all by Q4 2022.
- Devs/team ignoring questions about contract red flags: They would be brushing them off as FUD and banning/blocking the asker, or giving weak excuses for having them (“mint function is needed for staking”, “we’ll renounce ownership right after launch”, etc.)
- Cold DMs: Project is shilled via cold DMs, especially on Telegram.
- False audit claims: They claim to be audited/KYCed/registered company, but either don’t provide links, or they have links to fake sites/certs.
- Suspicious partnerships: Claims of partnerships with other projects/companies that are not backed up or proven in any way.
“The list could go on, but it all boils down to trust. If the devs can rug a project, you have to ask yourself if you trust them not to–and if you do trust them not to, why?” Chris said.
DYOR and rug pull checker
The best way to avoid being caught out by a rug pull is to do your own research before investing in any crypto project. Look for red flags that might indicate a rug pull is about to happen, and if you have any doubts, don’t invest. Remember, it’s better to be safe than sorry.
You can also check with tools such as rug pull checkers. There are a few rug pull checkers out there, such as:
These can be helpful in identifying red flags that might indicate a rug pull is about to happen.
How have rug pulls changed?
Since the inception of crypto rug pulls, there have been changes made in order to con users into investing in such scams. Unfortunately, given the exponential rise in these types of scams as noted by Chainalysis, they seem to be succeeding.
“I’ve definitely seen more effort being put into passing off scam projects as legitimate ones. During the last bull run, scammers setting up a project would have a Telegram channel and maybe a Twitter account, and that was about it. There was so much hype, and so many projects going 500x after launch that they didn’t need much else,” Chris noted.
“Launch a token based on an Elon Musk tweet or some dog-related theme, and people couldn’t throw money at it fast enough. But, as hype died down, markets cooled off, and people started becoming a bit more cautious, scammers had to adapt,” he said.
The way these scammers have adapted is by putting more effort into making the project seem legitimate and sustainable, but the project would be anything but that. “Now, they’ll have websites and whitepapers for their scam project. They’ll stand up fake audit sites, and have ‘previews’ of their supposedly upcoming NFT project or P2E game,” he observed.
“During presales, I’ve seen scammers make multiple buys to give the appearance of the project being popular, making people FOMO in before the hard cap is reached. I’ve also seen projects wait 2-3 days or more after launch before rugging, to further give the appearance that they’re legit, and bring more buyers in. Grifters are constantly upping their game,” Chris warned.
The future of rug pulls
Rug pulls might be here to stay, and as scammers up their game, users have to be aware of how to stray away from such scams. “I’m a firm believer that education is the best security, because ultimately it doesn’t matter what safety features are in place or what tools are being used, if a person wants to throw money at a project, they’re going to do it,” Chris noted.
“That said, one thing I would love to see is token launchpads like DxSale and PinkSale actually exercising some duty of care toward investors. Vet the tokens before allowing them to launch on the platform, or make devs put up some amount of collateral that they forfeit to presale investors if the project rugs within X days of launch,” he pointed out.
Nonetheless, he mused that nothing like that will happen “until there is accountability for launching or enabling a rug pull.” If there are “zero consequences for platforms like DxSale and PinkSale if they launch a project that rugs”, they have no real incentive to change what they’re doing.
“If we really want to help people avoid falling victim to rug pulls and honeypots, we need to go right to the source of things, and make it harder for such projects to even be launched,” he said.