How to Avoid ‘Rug Pulls’ in Crypto
The cryptocurrency industry has witnessed significant growth since its beginning, and investing in it has proven more profitable than most long-term investments. However, it is essential to remain vigilant against the numerous fraudulent activities and scams in the industry, including recent crypto rug pulls.
According to recent research, crypto rug pulls accounted for nearly a third of all revenue generated from cryptocurrency-related scams, resulting in billions in losses and an increasing number of victims from 2020 to date.
What is a Rug Pull?
A rug pull is a type of crypto scam where the developers of a particular cryptocurrency or decentralized finance (DeFi) project pull out their investments and disappear with investors’ funds. This type of scam is particularly damaging because it happens suddenly, without any prior warning, and leaves investors with no way to recover their funds. Additionally, rug pulls often occur in new and unregulated projects that need proper due diligence and transparency. Therefore, it is essential to carefully evaluate the legitimacy of any new investment opportunity before committing funds.
Rug pulls typically occur in decentralized projects where the developers are anonymous, making it difficult for investors to track them down. These scams often involve promising high returns on investment or unique features, which attract investors to the project. However, once the developers have raised enough funds, they pull out their investments and abandon the project, leaving investors with worthless tokens.
Examples of rug pulls in crypto history
After understanding how do crypto rug pulls work, it’s time to go through a list of crypto rug pulls examples in history:
Squid Game
In October 2021, Squid Game (SQUID) emerged as a popular cryptocurrency. Despite not being directly associated with the Netflix series Squid Game, SQUID was a meme token inspired by it. As it gained attention on social media platforms, many people believed it related to the show. As a result, SQUID’s price shot up dramatically following its launch. Between October 26 and November 1, the token’s value surged by almost 23 million percent, reaching $2,861.80 from just a few cents. However, the developers of SQUID then sold tokens worth $3.3 million, causing the token’s value to break down.
OneCoin
The fraudulent OneCoin was a cryptocurrency-based Ponzi scheme created by OneCoin Ltd. and OneLife Network Ltd. Its founder, Bulgarian national Ruja Ignatova, disappeared in 2017 after raising about $4 billion through this scheme. OneCoin’s primary business model involved the sale of course materials, and it operated as a multi-level marketing scheme that rewarded buyers for recruiting new buyers. However, the coin was not traded actively, nor could it be used to purchase anything.
After issuing a warrant for her arrest, the founder vanished, leaving control of the scheme to her brother, Konstantin Ignatov. He was arrested in 2019 and ultimately pleaded guilty to fraud and money laundering charges.
Luna Yield
Luna Yield, the popular project launched on Solpad, disappeared with nearly $6.7 million worth of digital currencies. Despite promoting itself as a legitimate project aimed at optimizing yield farming for users and receiving significant support from the Terra ecosystem, Luna transferred funds to Tornado cash three days after its official launch to avoid detection and subsequently shut down its website. So far, Luna is one of the biggest rug pulls in the history of the Solana blockchain, with investors experiencing a loss of nearly $10 million.
How to identify rug pulls?
As mentioned before, a rug pull is a type of fraud in the crypto market that involves a sudden withdrawal of liquidity by the founders of a cryptocurrency project, leaving investors with worthless tokens. Here are four ways to identify rug pulls in crypto:
Social Authority
Observing a cryptocurrency project from a distance is best to begin evaluating a cryptocurrency project and identify what a crypto scam is. This process means examining how the founders market themselves. Is there a genuine crypto community that believes in the project and its purpose? Or are mainstream celebrities and popular YouTubers promoting it through sponsored videos or social media posts, potentially signaling a crypto trading scam? Legitimate projects usually avoid these tactics because they know it appears suspicious, and these influencers may need to learn more about crypto or the project they are promoting.
Reputable and well-designed projects don’t need unrelated high-profile names to promote them. Instead, their marketing is handled by the project’s team and the community they have attracted. If you notice sudden interest from high-profile people without prior experience with cryptocurrency, this could be a red flag that the project is a potential scam. However, distinguishing between genuine influencers and bad actors can be difficult, leading to falling for a crypto scam.
Project’s Liquidity
One way to identify crypto fraud and rug pulls is by paying attention to a project’s liquidity. Liquidity can reveal much about the potential for a rug pull, a common form of crypto fraud. A project with very low liquidity is a red flag for crypto fraud detection. Such projects are easy to manipulate, making them an attractive target for scammers who engage in crypto fraud. It is important to note that a project with low liquidity means that the team behind the project has not invested much money in it yet, so it is easy to manipulate the token price for crypto fraud.
On the other hand, if a project has locked liquidity, it means the team has locked the liquidity for a specified period, making it harder for scammers to carry out a rug pull and engage in crypto fraud. Although locked liquidity does not guarantee a scam-free project, it provides some reassurance for crypto fraud detection. Different projects have varying goals and mechanics; thus, examining each project carefully before investing is crucial for avoiding crypto fraud.
Token Allocation
When investing in a cryptocurrency project, token allocation is the third major thing to consider. A token allocation refers to the number of coins held in the top wallets, also known as whales. It is essential to check this information because a small group of wallets holding a significant percentage of the total tokens could signal a potential risk for investors. This is because whale wallets could decide to sell off their tokens at any given time, causing the token’s value to drop rapidly.
Fortunately, checking token allocation is a straightforward process. Blockchain explorer platforms like Etherscan and BscScan allow investors to enter the smart contract address of any project built on the Ethereum or Binance Smart Chain networks. These services list the wallets that hold the most project tokens. It is recommended to avoid projects where the top 10 wallets hold over 15% or 20% of all available tokens.
Project Whitepaper
The Whitepaper of a cryptocurrency project is an important piece of information that investors should take the time to read before investing. It provides valuable insight into the project’s mission statement, roadmap, and overall goals. By understanding what a project aims to achieve, investors can make more informed decisions and avoid rug pulls.
The Whitepaper can also serve as an indicator of the project’s legitimacy. Many fraudulent projects lack a reliable Whitepaper and use buzzwords to make themselves sound legitimate. If investors find themselves reading through a Whitepaper and needing help understanding more about the project than before, it is a clear sign that the project is not worth investing in. In short, a solid Whitepaper is a fundamental requirement for any serious cryptocurrency project, and investors should always take the time to review it before making any investment decisions.
Best advice to avoid rug pulls
To help you avoid rug pulls, here are four tips:
- Do your research: In the cryptocurrency world, it’s common for people to hide their identities, but reputable projects usually have websites and sources that demonstrate their credibility. Smart contracts often establish the legitimacy of most crypto projects. In addition, you don’t need to be a tech expert to understand how a project works.
- Diversify your portfolio: Diversification is a key aspect of risk management. Don’t put all of your money into one project, particularly if it appears to be a high-risk investment. Diversifying your portfolio with investments in various projects can help mitigate your overall risk, even if one turns out to be a rug pull.
- Beware of FOMO: Avoid acting based on your fear of missing out. Bad actors frequently over-hype their projects to lure investors to FOMO. Fortunately, multiple online tools are available to assist you in quickly identifying a scam, such as Token Sniffer and Rug Doctor.
- Watch out for suspicious spikes in token value: Be wary of tokens whose prices skyrocket within a few hours or days, similar to pump-and-dump schemes. If you see an asset with a sudden rise in value, try to determine what caused it. If you cannot identify any new partnerships, listings, significant product announcements, or significant developments, it may be a tactic to draw you to FOMO into the project.
Conclusion
DeFi and NFT have led to an increase in cryptocurrency-related scams. However, investors can protect themselves from falling victim to these worthless projects by being vigilant, looking out for red flags, and implementing measures such as thorough research, diversification, and using reputable platforms for cryptocurrency fraud prevention.
FAQ
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