What is a Rug Pull in Crypto?
The cryptocurrency industry has come a long way with phenomenal growth in the last 11 years. While the industry has brought a lot of good to investors, like any other industry, it has come with it’s own bad. There have been lots of scams, hacks and attacks that have resulted in billions of dollars lost in crypto over the years.
A new and emerging scam is a rug pull. This is very common with the DeFi ecosystem which has become so popular recently. Decentralized Exchanges (DEXs) suffer such attacks as their design allows anyone to use the platform without any form of restriction.
What is a rug pull?
Imagine standing on a rug and someone pulls the rug from one edge. Unless the rug is glued to the floor in some way, it will sweep you off your feet and you could fall flat on the floor. This term is used to describe the experience of traders using DEX to trade and end up in an exit scam.
DEXs depend so much on individual stakers to provide liquidity through liquidity pools for smooth trading to take place. They are also decentralized and so have no central control, which makes every user to be in charge and no one is in charge. This naturally makes room for legitimate users to enjoy the privilege of decentralization and also allows fraudulent users to freely perpetrate crimes as well.
Anyone can list a token on a DEX which is very different from a centralized exchange where token owners have to apply and gain approval. This characteristic of DeFi has made it possible for just anyone to launch an ERC20 token on a DEX such as Uniswap without any restrictions and through this, investors make significant profits by trading DeFi assets.
A rug pull basically happens when someone or a group of persons drain the liquidity pool, making it impossible for traders to trade their tokens. For instance, tokens are traded against ETH, and the unavailability of ETH in the liquidity pool makes it impossible to trade such a token. The rise in the number of rug pulls calls for more caution when investing in DeFi tokens.
How rug pulls work?
The DeFi ecosystem gives developers freedom to create their own random tokens on Ethereum and then list them on DEXs. Some of the developers take advantage of the privilege to scam investors by creating tokens with little or no value and listing them on the DEX platforms. Several of such tokens have flooded the space recently and more are coming up every day.
When they are about to list the token on an exchange, the teams trade such tokens for ETH in what they call token sales. Investors use ETH to buy the tokens in the hope that the tokens will appreciate in value and they can trade it to get more ETH back. The team however takes their ETH and disappears, leaving the investors with tokens with no value.
Investors have lost millions of dollars through this process and this is not going away anytime soon. The only way out is to learn how to avoid such scams.
How to avoid rug pulls?
Rug pulls can cost you your investment and there are several DeFi projects coming up these days which can be potentially profitable as well. Therefore the key is knowing which projects to invest in and which ones to stay away from. This boils down to doing your own research on projects you intend to invest in. The following are ways you can check the legitimacy of any project.
Amount of liquidity the developers owns
Always check the amount of liquidity the owner(s) of the project own. You can check that by checking the top holders of the token. The first result is most of the time the burn address, remove that percentage of the total. Then check the biggest holders of the token and the distribution of it. Platforms like PancakeSwap and Uniswap are mostly labeled.
GitHub is literally the code base hub for developing DeFi projects. When you search for a project on the platform, you can see the development activities on it in. If the project is not undergoing active development and is a fork of another project, it could be a bad sign and you shouldn’t put your money in it.
What is the team like?
Every project has a team behind it, but not all teams are reliable. Try to find out the people behind the project by checking on LinkedIn for instance. If the team is made up of reliable people who have been in the space for a while, good. Otherwise, it could be a bad sign. Although DeFi teams are usually anonymous, it will pay you if you can get this information.
Look for pools with bigger liquidity
Scammers don’t usually have so much money in the liquidity pool. You should check how much is in the pool. A liquidity pool with at least $50,000 in it is not likely to be a potential rug pull as scammers don’t usually put so much in a project. This list is by no means exhaustive and you should do more research such as their whitepaper, website etc. to prove that it is a safe project before investing.