In the world of crypto and Web3 projects, promises of groundbreaking innovations often come hand in hand with the lurking threat of rug pulls. According to Chainalysis, a staggering $2.8 billion was syphoned by rug pulls in 2021, constituting a significant chunk of crypto scam revenue in what was arguably the most bullish DeFi year to date.
In light of this, it’s imperative that crypto and DeFi investors are equipped with the knowledge to discern rug pulls, pump and dump schemes, and other nefarious actors within the blockchain space.
What is a Rug Pull
A rug puller is an entity or a group that initiates a new crypto project with the intent of artificially inflating its price, only to swiftly offload their tokens and vanish with a substantial sum of freshly acquired funds. This unscrupulous act, commonly referred to as a ‘pump and dump,’ invariably leads to investors being left with holdings virtually worthless.
Methods Employed by Rug Pulls
Pump and Dumps
Dumping involves rug pulls swiftly selling off their token holdings once the project gains substantial hype and value. This leaves the community holding tokens with little to no value. While it’s not inherently unethical for projects to trade their own tokens, it becomes problematic when developers subsequently abandon the project and its loyal investors.
Liquidity Stealing
Liquidity stealing is perhaps the most prevalent type of rug pull in the DeFi space. It essentially entails creating a new token, generating buzz around it, and listing it on a decentralised exchange (DEX) while providing liquidity. The rug puller then employs various tactics to artificially inflate the token’s price – where once a significant amount of capital is invested, they execute the rug pull by removing the liquidity, resulting in a rapid decline in the token’s value.
Limiting Sell Orders
Limiting sell orders is a subtle method that involves coding tokens so that only the developers can sell them. Devs then wait for retail investors to ape-in, where after positive price action is observed, they then dump their positions whilst leaving behind a worthless token.
Spotting a Crypto Rug Pull
Unverified Teams and Developers
Trust is established when a team is transparent and ‘doxxed.’ Conversely, when a project is led by a pseudo-anonymous team with no identifiable faces, skepticism is warranted. Unidentifiable founders or a team lacking a proven track record should always raise red flags.
Lack of Liquidity Locking
A project without locked liquidity is cause for concern, as it means founders can abscond with the entirety of the liquidity. Investors should ensure liquidity is secured through time-locked smart contracts, ideally lasting 3-5 years from the project’s launch.
Sell Order Limitations
If you encounter restrictions on selling the tokens you’ve invested in, it’s a clear warning sign. While challenging to detect on the surface, it can be identified by attempting to sell a small amount of the token immediately after purchase.
Volatile Price Movements with Limited Holders
Drastic price swings on new tokens are a signal of caution. Sharp price increases may precede a subsequent drop, while a small number of holders makes a token susceptible to manipulation.
Unrealistically High Yields
Projects promising extraordinarily high annual percentage yields (APY) should raise suspicions- or in other words, if it sounds too good to be true, it likely is.
Absence of External Audit
Trustworthy projects undergo formal audits from reputable third parties to ensure their code is free from malicious elements. Further, the absence of an audit or confirmation from the third-party in question should be deemed red flags.
In conclusion, the dynamic world of crypto requires a wealth of vigilance in order to avoid rug pulls. However by recognising the aforementioned signs and conducting thorough due diligence, you can rather proficiently mitigate the risks associated with unscrupulous actors in the blockchain space.