You’re new to cryptocurrency. You decided to deposit your hard-earned cash on “the next biggest” cryptocurrency you saw on Instagram, Twitter, or YouTube.
You’re just following what you see on social media without prior knowledge of cryptocurrency. Besides, it just costs a few bucks and many people seem to be chasing it. Obviously, you need a VIP spot, and you immediately buy-in.
After a while, upon checking your wallet, your potential profits immediately jump threefold.
Fast forward to the next day, the market suddenly dropped. Your crypto is now worth zero! They pull the rug underneath your feet, sending you tumbling down with all your money gone.
What is the Meaning of Rug Pull
The crypto scam is pretty simple. It begins when developers produce a bogus token that is then swapped for valuable crypto. Developers sometimes use unscrupulous tactics to accumulate investors' funds by hyping the project. They'll suddenly disappear once they've collected a significant amount of valuable crypto.
The DeFi system is commonly used to pull off crypto scams, particularly Dexes or decentralized exchange protocols. Usually, the crypto scam is perpetrated by malicious developers. They produce a "shit coin" and sell it to unsuspecting investors on a Dex. The shit coin can then be paired with a number one cryptocurrency that actually has value. Once a significant quantity of cryptocurrency is swapped with the shit coin, the creators can vanish with investors' funds from the liquidity pool.
In contrast to centralized exchanges, Dexes permit users to register their useless tokens and get away without any auditing needed. Plus, shit coins are comparatively easier to create. Such tokens can be produced out of thin air by using supported by an open-source blockchain protocol like Ethereum.
A crypto scam may be initiated from the beginning (or even months after) the Initial Coin Offering (ICO). The rug-pulling scammers would even produce unbelievably effective promotional materials to lure noob investors. Shit coins can be easily spotted as they are usually loud on social media.
There are three main ways that this could happen:
I. Yanking Liquidity
Whenever developers create a cryptocurrency, they must also create a way for new crypto investors to trade that token. They need to put a portion of valuable tokens and a portion of newly-minted worthless tokens. Both of these go into a trading pool. This method allows new investors to deposit fiat money to acquire some of the valuable tokens. The developers will then give their newly minted worthless tokens to the new investors in exchange for their valuable tokens.
As more investors put money into the system, the price of the worthless token increases. The developer can then initiate a crypto trading scam by pulling out their initial liquidity. Therefore, they will end up with more valuable tokens (aka your money). Also, crypto investors won’t be able to trade because the liquidity pool has nothing in it to allow trades.
II. Developers Selling Their Shares
Basically, crooked developers create worthless tokens and sell them to investors. Any developer who has knowledge of blockchain technology can create a token. However, a token gains its value from investors’ “trust”, which can be generated if the token actually does something. Otherwise, it’s considered a crypto scam.
The problem is that some developers can convince many people that their token has real value. “This new token will be released soon, and it’ll be the next Bitcoin or Ethereum!” They sell it to a bunch of newbie crypto investors. When the price of the token skyrockets, the developers will immediately sell the tokens they gave themselves during the launch. In the end, investors will be holding a worthless token that doesn’t really do anything.
III. Removing Your Ability to Sell
Some token creators can include a piece of code to a token that will not allow investors to sell their holdings. However, the code only allows the developers to sell. So, the token price will only go up because people appear to be HODLING really tight.
When the token price becomes really high, the rug pull happens. The developers will sell the tokens they either gave themselves or bought earlier during the launch.
Tips to Avoid Participating in a Rug Pull
New coins and tokens are popping up everywhere.
Multiple cryptocurrencies have reached the moon, allowing some investors to become millionaires in a matter of days or weeks. However, many unlucky cryptocurrency traders and investors lost their money because of rug pulls.
If you want to stay on the winning side of the spectrum, here are the ways you can do to avoid being involved in a rug pull.
- Look for Early Signs of Rug Pull in Crypto
Participating in a rug pull scenario can be avoided if you know how to spot the red flags. Here are some of them:
> Suspicious Amount of Liquidity
Before investing in a particular token, always check the amount of its liquidity first. Any token with a small amount of liquidity can be easily manipulated by its developers. It also means that its developers haven’t raised enough funding for the token. On the other hand, legit tokens have millions of dollars in liquidity, such as Uniswap, Kyber, and Balancer.
> Liquidity at Developers’ Disposal
Generally, the liquidity of a decentralized exchange should be time-locked. Developers should not own the liquidity pool. Otherwise, they could easily manipulate or drain the liquidity pool when the time is right. Unsuspecting crypto traders could fall victim to this classic rug pull scam, especially when some marketing is involved. So, always check the liquidity status before putting our money on a protocol.
> Mooning of Price Within Hours
Rug pulls take advantage of the FOMO mentality of crypto traders. Bandwagon traps could easily catch newbies, and a mooning crypto is the best bait. So, when a coin skyrockets within a few hours, it's reasonable to get suspicious. If the hype is only fueled by FOMO, it's a good decision to distance yourself from such "opportunities".
> Influx of Influencers and Promotions
Don’t let influencers tell you what specific cryptocurrencies you should buy. A rug pull is evident when there’s a sudden influx of influencers promoting a certain cryptocurrency. Celebrities won’t look at the code or white paper of the token. Their popularity doesn’t equate to good fundamentals. So, don’t let them pick the token you would invest in.
> White Paper = Sales Page
A crypto's white paper is supposed to explain how the coin works, including its goals, timelines, strategies, tokenomics, and value proposition. Therefore, a white paper that sounds like a sales pitch clearly shows that a rug pull is about to happen soon. Generally, but not all the time, white papers with less than 20 pages can indicate that the project is a crypto trading scam.
> Malicious or Copy-Pasted Codes
As a regular crypto investor, you may not know how to inspect a token’s code. Fortunately, you can go to Rug Doctor to check the project’s code. The website reviews smart contract codes and spots common rug pull tactics. You can also check TokenSniffer.com to compare a token’s code with other existing crypto codes. If a token is 80% to 100% similar to another token, press the rug pull button and run with your money.
> Look Out for Whales
To spot this particular red flag, you have to use a blockchain explorer, such as CoinMarketCap, Blockchain.com, and Tokenview. A blockchain explorer will let you look at all the tokens available in the market. Search for a particular token, and you will see the list of all the top token holders (whales). A rug pull may happen if one to three wallets hold more than 20% of the token supply combined.
2. Do Your Own Research (DYOR)
When entering the cryptosphere, any experienced crypto investor will tell you to do your own research first. You can do this properly by asking four major questions:
- Is it economically active?
- What is it, exactly?
- How does it work?
- Is it making any progress?
You can find out more on how you can properly DYOR in this blog.
3. Seek Help from Reliable Communities
Staying updated with the crypto-verse is crucial to crypto trading and investing. But, as a beginner, it would be difficult to sift through an ocean of information (and disinformation).
Telegram and Discord channels and groups are extremely useful when doing your own research. Compared to reading or watching crypto news and explainers, seeking help from fellow traders is easier and faster. If you can find one to two reliable channels/groups, you can easily ask questions, and let experts in the group help you -- instead of scouring the entire internet.
On the other hand, Discord and Telegram channels could also be a breeding ground for crypto trading scams and misinformation. There are hundreds, if not thousands, of pump-and-dump groups, fake channels, and crypto customer service impersonators in Discord and Telegram.
Fortunately, there are red flags you can watch out for to avoid joining malicious crypto Telegram and Discord groups.
> Duplicate Telegram Groups
Fake Telegram and Discord groups can be easily created by duplicating an original group, including the admin profile and other customizations. They usually offer tokens or NFTs at a “discounted price” or “first-come, first-served” basis.
Remember: When it comes to token offerings, if it’s too good to be true, it probably is.
> Fake Admins from Groups
Malicious individuals could be a member of a reliable Telegram or Discord group. They prey on unsuspecting newbie traders who seem to lack knowledge in crypto.
Fake admins will directly message you and introduce themselves as one of the group's admins. After gaining your trust, they will request your private keys or seed phrase. In some cases, fake admins will ask you to access a platform, which will allow them to fish out private information.
Pro Tip: If someone you don’t know messages you regarding crypto, block them immediately – No-Questions-Asked!
> Pump-and-Dump Groups
In these scams, you will hear hyped lines, like "We will inform our VIP members about the coin a day before its release. Hurry! Join our group now!" As a rule of thumb, don't join groups (or channels) that are constantly talking about pumping the token.
WARNING: Be Cautious and Avoid Rug Pulls
Trading and investing in crypto involves a lot of risks.
You can make millions within hours or lose your entire savings after a rug pull incident. If you’re new to crypto investing or trading, look for tell-tale signs of rug pull in crypto before swapping your real coins for mere tokens.
As always, be cautious and DYOR.