With the creation of cryptocurrencies came lucrative financial opportunities, but like opening a Pandora’s box, sinister scams, like Rug Pulls, were released.
According to Payments Dive, the US crypto market lost over $3.9 billion to crypto scams in 2023, a $1.33 billion increase from 2022 (just in the U.S.).
Recommended reading: Top 5 Effective Crypto Technical Analysis Signals in 2024
Today, crypto scams have reached staggering heights, with $25 billion lost in the global crypto market. With a record of 400 instances in 2023, these cunning scams continue to wreak havoc on unsuspecting investors—and the numbers keep climbing.
In this article, we will discuss rug pulls and how to avoid being a victim of one.
Key Takeaway
- Rug pulls occur when a DeFi project’s developers or founders suddenly withdraw all the funds from the project, leaving investors with worthless tokens or assets.
- Scammers create a buzz around their project, promising unusually high returns or guaranteed profits to lure in unsuspecting investors.
- Investors can avoid falling victim to rug pulls by thoroughly researching the project, verifying the team’s credentials, checking for smart contract audits, and being cautious of unrealistic promises or guarantees.
Rug Pulls
Since its inception, rug pulls have ravaged the global DeFi (Decentralized finance) market, resulting in staggering losses of billions of dollars.
For starters, the word ‘rug pull’ originated from the notion that scammers pull the rug out from under unsuspecting investors’ feet, suddenly leaving them with devastating financial losses.
A “rug pull” is a scam in which developers mostly create a fake project (such as a crypto or NFT project), promise high returns, and then steal investors’ money.
To lure investors to their fake project, they list their token on decentralized exchanges (DEXs) like Uniswap or Pancakeswap, pair it with popular cryptocurrencies like Ethereum, Solana, or TON, and promote it through social media and crypto influencers.
Once many investors who easily give in to FOMO buy the token, the developers withdraw all the funds, causing the token’s price to drop to zero.
Most rug pull projects often involve:
- False promises or too-good-to-be-true promises of high returns (e.g., 100X).
- Temporary hype on social media.
- They inject liquidity to gain investor trust.
- Collaborating with influencers or key opinion leaders
- Manipulating token value to deceive investors.
In the end, victims are left with worthless tokens and financial losses.
A Rug pull can happen within a few days or might take years. This is where the concepts of “Hard rug pulls” and “Soft rug pulls” come in.
How they work
To understand how Rug Pulls work, we must first examine the psychological tactics that make them so effective.
The crypto space is a breeding ground for get-rich-quick dreams, and the promise of overnight fortunes can cloud even the most brilliant minds.
Recommended reading: Trust and Transparency in the Crypto Community
Scammers know this and prey on this vulnerability, exploiting emotions and knowledge gaps to execute their deceitful schemes.
Some of the emotional and knowledge-based tactics used by rug pull con artists include:
- Greed: This is a primary psychological tactic. Scammers exploit investors’ desire to make quick profits and high returns.
- Fear of missing out (FOMO): They create a sense of urgency, making investors feel like they’ll miss out on a lucrative opportunity if they invest slowly.
- Social proof: Scammers use influencers and fake testimonials to create the illusion of a successful project.
- Lack of knowledge: Investors may need to understand the cryptocurrency market or the risks involved fully.
- Trust: Scammers may pose as trusted authorities or partners with reputable organizations to gain investors’ confidence.
Understanding how rug pulls work on the mind allows you to recognize red flags, avoid falling victim to these scams, and keep your funds safe.
Here is how Rug Pulls work.
- Token creation: The scammers involved create a new cryptocurrency token or NFT project, often with a convincing name, logo, and website.
- Promotion: Then, they promote the token through social media, crypto influencers, and online communities.
As they do so, they make false promises of high returns, guaranteed profits, or participation in something revolutionary.
- Listing on DEX: Next, they list the token on a decentralized exchange (DEX) like Sushiswap or Balancer, where it can be traded for other cryptocurrencies.
- Liquidity pool creation: They create a liquidity pool, which allows investors to buy and sell the token.
- Pumping the price: To attract more investors, scammers artificially inflate the token’s price by buying it themselves or paying others.
- Hype generation: Once the price has been pumped, they create a sense of urgency and FOMO (fear of missing out) among investors, encouraging them to buy the token quickly (sometimes through a secret sale).
- Rug pull: Once the scammers have enlisted many investors to buy the token, they withdraw all the funds from the liquidity pool, causing the token’s price to drop to zero.
They immediately deactivate their social media handles or go private, block investors who call them out, and sometimes flee the country.
“Due diligence is your best defense. Always research the team, review the project’s code, and check for locked liquidity before investing in any crypto project.”
Types Of Rug Pulls
There are two categories of rug pull scams. They include the Hard and Soft rug pull.
Under these categories are different types. Here is an explanation of how they work.
Hard rug pull
A hard rug pull occurs when scammers drain all the liquidity from a token or project, causing its price to drop to almost zero, making it nearly impossible for investors to sell their tokens.
This type of rug pull happens quickly or within a few days after launching the token. It is often accompanied by a complete project abandonment, with the scammers disappearing with the funds.
Types of this scam include:
1. Liquidity Draining
Here, scammers create a token, list it on a DEX, and encourage investors to buy. Once enough liquidity is pooled, they withdraw all the funds, leaving investors with worthless tokens.
Example: The scammer creates a token called ‘SunnyCoin’ on the Ethereum blockchain and lists it on Uniswap, a decentralized exchange. They promote it heavily on social media, attracting investors who add liquidity to the pool (a mix of ETH and SunnyCoin). The scammer, who controls most of the tokens, waits for the price to peak, then sells off their large share, causing the token’s value to plummet and triggering panic among investors. Finally, the scammer withdraws all the ETH from the liquidity pool, leaving SunnyCoin holders with worthless tokens they cannot sell.
2. Flash loan attacks
Flash loans are DeFi loans that allow borrowers to access liquidity without collateral.
They are called “flash” loans because they are typically taken out and repaid quickly, often in the same blockchain block.
Scammers use these loans to manipulate token prices and dump the tokens, causing a price crash.
Example: A scammer takes out a flash loan of 100,000 DAI to buy up “PumpToken,” driving the price from $0.10 to $1.00.
Then, they sell the tokens, causing the price to drop to $0.01, leaving investors who bought in at the peak with a 99% loss.
3. Honeypot traps
Scammers create a smart contract that appears to be a legitimate token sale, but unknowingly to investors, it is a trap designed to drain their funds.
Example: The scammer creates a smart contract for “GrooveToken” that promises a 100% return on investment.
Investors send their ETH to the contract to make sure they get all the benefits, but it’s designed to drain their funds instead of providing a return.
Soft rug pull
Soft rug pulls are also known as “slow rug pulls.”
They occur when the scammers gradually drain the liquidity from a token or project over a while (weeks or years, depending on the scammers), often while maintaining a facade of activity and engagement.
This type of rug pull can be more challenging to detect, as the price may stay relatively high, and the scammers may continue to provide updates and support to avoid raising suspicion.
1. Pump & dump
Scammers artificially inflate the token’s price by buying it themselves or paying others. They then sell their shares, causing the price to plummet, leaving investors with significant losses.
Example: A group of scammers creates a Telegram channel promoting “MountainToken.” They buy the token, driving the price from $0.01 to $1.00.
They then sell their tokens over time, causing the price to drop to $0.001 within a few weeks of its launch. Investors who bought in at the peak then lost 99%.
2. Fake token listings & partnership
Scammers create a fake token listing on a DEX, convincing investors to buy.
They announce fake partnerships or collaborations with industry leaders to boost the token’s price. After they achieve this, they disappear with the funds after a while.
Example: Scammers create a fake listing for “HappyCoin” on PancakeSwap, complete with phony documentation and a convincing website.
The scammers then announce a fake partnership between their token and a well-known company like Microsoft.
Investors buy in, thinking it’s a legitimate partnership with Google. The scammers then disappear with the funds.
Note: Some of these scams overlap and may be done simultaneously.
How To Protect Yourself From A Rug Pull Scam
- Research thoroughly: Look into the project’s team, experience, and track record. Check for red flags like anonymous teams or fake profiles. A legitimate project should have a transparent team with a proven history.
- Verify smart contracts: Use tools like Etherscan or BscScan to verify the smart contract’s code and ensure reputable firms audit it. This helps ensure the contract is secure and functions as intended.
- Check liquidity: Ensure sufficient liquidity in the project’s liquidity pool to avoid price manipulation. A healthy liquidity pool indicates a stable project.
- Be cautious of high yields: Unrealistically high returns often indicate a scam. Be wary of projects promising unusually high returns with little risk.
- Monitor project activity: Regularly check the project’s social media, GitHub, and updates to ensure consistent development and communication. A legitimate project should have regular updates and active communication channels.
- Only invest what you can afford: Set a budget and stick to it to minimize potential losses. Never invest more than you can afford to lose.
- Diversify your portfolio: Spread investments across multiple projects to reduce risk. This helps minimize losses if one project fails.
- Stay informed: Follow reputable sources and stay up-to-date on market trends and potential scams. Stay educated on DeFi and cryptocurrency developments.
- Use secure wallets: Store your funds in reputable wallets like MetaMask or Ledger. Avoid using exchange wallets or unsecured wallets.
- Be patient: Avoid impulsive decisions based on FOMO (fear of missing out). Take time to research and consider investments carefully.
“The allure of quick profits in DeFi can often blind investors to the red flags of rug pull scams—promises of guaranteed returns and anonymous teams are warning signs.”
What to Do When You Have Been Rug-Pulled
However, if you’ve been rug-pulled and don’t know what to do, here are some actions you should take immediately.
Here are the steps to take when you’ve been rug pulled, with additional context:
- Stay calm: Panic can lead to poor decision-making, such as trying to recover losses by investing in another risky project. Take a step back, assess the situation, and think clearly.
- Assess the situation: Understanding how much you lost, which tokens or assets were affected, and the extent of the scam will help you determine the best course of action.
- Report the incident: Inform the DeFi platform, exchange, or relevant authorities (e.g., SEC, FTC) about the scam. This can help prevent further damage and aid in investigations.
- Gather information: Collect transaction IDs, wallet addresses, and any communication with the scammers. This evidence can be crucial for legal action or reporting to authorities.
- Join forces with other victims: Collaborate with others affected by the same scam. Share information, coordinate efforts, and potentially pool resources for legal action.
- Consult with experts: Contact DeFi experts, lawyers, or law enforcement for guidance on how to proceed. They can help you understand your options and navigate the process.
- File a complaint: Report the incident to regulatory bodies like the SEC or FTC. This can help trigger investigations and lead to action against the scammers.
- Consider legal action: Take legal action against the scammers. This may involve filing a lawsuit or working with law enforcement to pursue criminal charges.
- Learn from the experience: Analyze what went wrong and how you can improve your investment strategies to avoid similar situations in the future.
- Time to move on: Don’t let the experience discourage you from investing in DeFi, but approach future investments with caution and a more critical eye.
Note: Recovering from a rug pull can be difficult, especially if you have invested so much money into a project. However, taking swift action and seeking help can improve your chances of getting your funds back.
Recommended reading: Cryptocurrency Hardware Security Modules (HSMs) Explained
Most Notable Rug Pull Scams
Here are some of the most notable rug pull scams in DeFi history:
1. Squid game token
In October 2021, a scammer created a token inspired by the popular Netflix show, promising a 10x return. The token price rose from $0.01 to $2,861 before the scammer drained the liquidity pool, leaving investors with significant losses.
2. AnubisDAO
Also, in October 2021, the creators of this project promised to create a decentralized lending protocol. However, the team behind the project disappeared with $60 million in investor funds.
3. DeFi100
A DeFi index token that promised to track the performance of top DeFi tokens. They went ahead to create the DeFi100 token in November 2020. However, the team behind the project drained the liquidity pool, causing a 98% price drop.
4. Alpha finance lab
Alpha Finance Lab was created as a DeFi project for decentralized lending in 2020. The team behind the project exploited a vulnerability in the smart contract, draining $37 million from the liquidity pool.
5. Furucombo
Furucombo started as a yield-farming DeFi project. The team behind the project exploited a vulnerability in the smart contract, draining $14 million from the liquidity pool.
Recommended reading: The Rise of Decentralized Finance (Defi)
Conclusion
Rug pulls pose a serious threat to investors, often resulting in significant financial losses and eroding trust in the DeFi ecosystem—even for seasoned traders.
However, by recognizing the warning signs, remaining vigilant, and prioritizing thorough research and due diligence, you can minimize your risk and better protect your investments.
FAQs
A “rug pull” is a type of cryptocurrency scam where developers or project leaders abandon a project and steal investors’ funds, often by draining the liquidity pool or freezing assets.
To avoid rug pull scams, research the project thoroughly, check the team’s credibility, and be cautious of unusually high returns or pressure to invest quickly. Also, invest only what you can afford to lose.
Warning signs of a potential rug-pull scam include anonymous or pseudonymous team members, unclear or complex project goals, unrealistic promises, and unregistered or unlicensed operations. Also, be wary of projects with poor transparency, inadequate security measures, or lacking community engagement.
