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What is a Rug Pull in Crypto? 

Some crypto coins on a rug close to a hole in the ground

You’ve probably seen a rug pull before on the big screen. It’s usually quite comical and a staple of slapstick spy movies. But when it comes to cryptocurrency, rug pulls are no laughing matter. So, what exactly are they? This piece will explore what rug pulls are, how to spot one and walk you through the biggest rug pulls the industry has ever seen. Let’s jump in!

What is a crypto rug pull? 

Decentralized finance (DeFi) has exploded in recent years and provided investors with fantastic opportunities to put their cryptocurrency to work. However, these very same opportunities have given way to a stark rise in crypto rug pulls – a type of exit scam.  

Rug pulls are one of the most common cryptocurrency scams, accounting for more than 25% of lost crypto funds in 2021.  

Cryptocurrency, and in particular DeFi, is a relatively new technology that isn’t universally understood. Scammers look to take advantage of the crypto-naive who may not be familiar with navigating the industry. 

Rug pulls are a form of theft. They often take the form of new crypto projects offering rates or incentives that are too good to be true. After the project receives substantial investments, the developers “pull the rug”, shut down operations, and make off with investors’ money. 

Figure 1 – A typical rug pull price chart

The crypto industry has a target on its back for these types of scams. Most public businesses have to operate within a strict set of government guidelines, reducing the wriggle-room for fraudulent behaviour. A crypto project, however, is inherently decentralized and lacks the same regulatory oversight as other companies. This leaves a backdoor open for scammers to work within a legal grey area. 

Did You Know?

In 2021, approximately $7.7 billion USD worth of cryptocurrency was stolen by scammers, according to the Chainalsyis Crime Report.

Types of rug pulls 

Liquidity theft 

Liquidity theft is the most common form of rug pull. This scam only works on decentralized exchanges (DEX), as it exploits a hole in the way liquidity pools work. 

A DEX provides customers with trustless trading – the ability to swap cryptocurrency without needing a third party to approve the transaction. To do this, they create liquidity pools, where investors lock up their crypto tokens in pairs and receive a portion of transaction fees as an incentive. 

Liquidity theft rug pulls happen by “project developers” minting a new cryptocurrency and creating a trading pair alongside a prominent token like Ethereum (ETH), Solana (SOL) or a stablecoin. 

The scammers will then attract investors to the project by offering a lucrative annual percentage yield (APY). As investors begin depositing the legitimate token into the liquidity pool, the scammers can take all of these “real” coins back from the pool at any time. 

Once the rug has been pulled and legitimate crypto is withdrawn, investors are left with nothing but a valueless scam token they can’t even trade.  

Limit selling orders 

This type of rug pull exploits the way modern crypto tokens are coded. These tokens are programmed with “smart contracts”, which can perform actions automatically without human intervention. It’s this very same functionality that forms the foundation of the entire DeFi ecosystem. 

Unfortunately, smart contracts are exploitable. Experienced coders can deploy code that only allows a newly-minted altcoin to be sold from a specific address. This means investors will dive into supporting a new project, only to find when they try and swap the coin, they are prevented from doing so.

As more people begin to buy the token, its value will likely jump – especially because only a select few people can sell it. Once the coin reaches a certain price point, the bad actors can sell off their tokens and make off with all of the investor’s money. Again, all that’s left behind is a worthless token that cannot be sold.  

Dumping 

Dumping is the only type of rug pull scam that isn’t unique to cryptocurrency. You may have heard the common phrase “pump and dump” among crypto investors.  

This scheme involves a developer, or anonymous investors, generating hype around their new token to drive its price upwards. After the coin becomes valuable enough, the scammer will then “dump” (sell) their portion of the token. In most schemes, the scammer(s) will own a significant percentage of the cryptocurrency’s total supply. 

The huge sell-off will wipe out most of the gains the coin initially made and will often trigger another massive sell-off from panicking investors. By the time it’s all said and done, a pumped and dumped coin will pretty much be worthless. 

Interesting Fact

Pump and dump scams have long plagued penny stocks on share markets around the world. This scheme is considered fraud, and illegal when done in a traditional financial market. However, it is not regulated the same way in cryptocurrency. Dumping crypto is considered unethical, but not necessarily illegal.

Hard rug pulls vs. soft rug pulls 

Rug pulls are often referred to as being either “hard” or “soft”. 

Hard rug pulls encompass liquidity theft and limit selling order scams. These rug pulls are outwardly malicious and involve a concentrated effort to defraud investors. The projects embroiled within hard rug pulls are never intended to succeed. 

Conversely, soft rug pulls aren’t quite as black or white and aren’t necessarily intentional scams. Pump and dump schemes are considered a soft rug pull. While investors will often lose out big on a soft rug pull, the token isn’t always unsalvageable. Holders can still sell and swap the leftover coins, albeit at a hugely reduced value. Occasionally, the developer will have nothing to do with the soft rug pull.  

Defrauding investors isn’t necessarily the project’s intention from the onset, and may instead be a result of failing finances, exploitation from investors or other variables.  

Are rug pulls illegal? 

Hard rug pulls are illegal. Perpetrators can be prosecuted and face jail time. 

Soft rug pulls aren’t illegal, although they are highly unethical. This is because the project’s operation doesn’t necessarily halt once dumped, and the coin may not have been developed with fraud in mind. 

Unfortunately, the unregulated nature of the cryptocurrency sector can make it difficult for the law to catch up with scammers of any type.

The biggest crypto rug pulls in crypto history 

OneCoin 

OneCoin was a stereotypical Ponzi scheme, primarily selling blockchain education courses that came with tokens that could supposedly “mine” the OneCoin cryptocurrency. “Employees” would get paid for referring new customers to the scheme, and so on.  

However, it turned out that OneCoin was never publicly traded and could only ever be sold on the OneCoin Exchange which had strict selling limits. Eventually, the exchange was shut down, and investors were left with tokens that were practically worthless. 

The rug pull lasted for 5 years, operating between 2014 and 2019. In that time, it’s estimated that $4 billion USD (approx. $5.8 billion AUD) was stolen from investors. 

Thodex 

Thodex operated as a centralized exchange out of Turkey, allowing customers to buy, sell and swap various cryptocurrencies. One day in late 2021, the exchange’s users woke up to withdrawals being disabled on the platform. 

The business’ CEO, Faruk Faith Ozer, quickly released a public statement claiming they had to temporarily shut down the platform due to a spate of cyber-attacks. Soon after, he mysteriously disappeared, and Thodex never re-enabled trading.  

This is a very rare example of rug pulls occurring in centralized finance. All in all, an estimated $2 billion USD was stolen from the exchange’s customers. 

Squid Game Token 

The Korean TV drama Squid Game took the world by storm in 2021. It spawned a legion of followers and hype surrounding the show – something that a group of scammers took advantage of. 

Aligning with the popularity of the associated Netflix show, Squid Game Token ballooned from being worth less than a cent to an absurd $2,856 USD in just a few weeks. 

However, there were two major issues. The first was the Squid Game Token had no official affiliation with the TV program and was on a crash course for copyright infringement. But before this could ever come to a head, investors started to realise they couldn’t sell the coin at all. 

In November 2021, the rug was pulled from underneath investors. The token “developers” removed liquidity and the price toppled from over $2,000 to being worth just a fraction of a cent. About $3.3 million USD was lost. 

Rug pull red flags 

There are a few ways to identify a cryptocurrency rug pull. Being diligent and performing independent research will go a long way to ensuring that you are always choosing established cryptocurrency projects.

Anonymous developers 

Cryptocurrency is a sector devoted to privacy and security. Quite a lot of legitimate projects have anonymous developers – the most obvious example being Bitcoin’s mythical Satoshi Nakamoto.  

However, this is often a red flag for investors. Most trustworthy anonymous developers have a strong social media presence and at least some traceable history in the blockchain industry. Be wary of anonymous projects, especially those without a whitepaper or with completely new social media accounts. 

The project appeared out of nowhere 

Rug pull scams have a habit of turning up overnight. Rug-pulled projects tend to experience massive price movement just hours after being launched. This can be an indication of a pump and dump scheme. A good idea is to look up these tokens on the relative network’s block explorer to see if they are established cryptocurrency projects. If there are only a few people accumulating the cryptocurrency, it is best to steer clear.   

Low liquidity 

Exploiting liquidity is a common crypto rug pull scam. An easy way to avoid this is to analyse a cryptocurrency’s liquidity pool on a decentralized exchange. A low level of liquidity should always be a red flag. In addition, if the project’s total value locked (TVL) is low or non-existent, it means developers can pull the rug at any time. 

Extensive marketing tactics 

Real cryptocurrency projects will have legitimate use-cases that form their selling point. Scam coins, on the other hand, don’t tend to do anything at all. To compensate, scammers will go on rampant marketing campaigns promoting high yields, joining a “community” or using FOMO tactics to trap investors.  

Extremely high yields 

The phrase “too good to be true” is one of the most important philosophies to have when investing in crypto. Many scam coins offer excessively high/unsustainable reward rates. If there’s no real reason for the inflated reward rate, the coin should be avoided. There’s a good chance the rug will be pulled before any of the rewards are ever paid out.

Key Takeaway

Rug pull scams will often have some of the same hallmarks to look out for. Anything that seems even remotely suspicious or too good to be true is probably worth avoiding. A great resource to use is the Is This Coin A Scam?, which gives cryptocurrencies an overall rating based on their project’s legitimacy.

Summary 

The growing interest in decentralized finance has created new projects and exciting opportunities for how people use their money. Unfortunately, the unregulated nature of DeFi has made it a haven for scammers trying to rob people of their investments. The importance of doing your own research and finding established projects has never been more paramount. This guide has explored the red flags to be aware of when deciding whether a cryptocurrency is legitimate or not. 

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