What is a rug pull and how to avoid it?
Investors have been losing astronomical sums because of rug pulls. Having become common within the crypto industry, here's what it is and how to protect yourself against this malicious practice.
A sudden abandonment of a project by its developers and the disappearance of funds related to the project. This is the typical profile for a rug pull. The NFT market as well as cryptocurrencies are concerned. The first rug pull of this year took place at the beginning of January. The creators of the Frosties collection of 8,888 NFTs amassed $1.3 million leaving behind 40,000 victims before decamping.
The most popular of the century is the one based on the crypto play-to-earn Squid Game. Using the name of the eponymous hit series, the scammers scooped up $3.3 million by taking a stock price of over $2,861 down to pennies within hours. There were, however, warning signs but they were not taken into account.
Rug Pull: Definition And Operation
The rug pull refers to the fact that the developers or other people responsible for a project disappear taking with them the funds invested. In these cases, the website in question no longer exists and the social media accounts are deleted. Cases of rug pull are very often linked to DeFi projects but more particularly those which are exchanged on decentralized exchanges where it is easy to create and list a token. Their purchase usually requires securing ETH which will be used to provide liquidity.
To amplify their gains, a large-scale media campaign is created to broaden the community and bring reluctant investors to take the plunge with a price that gains more than 50% in a daily session. The tokens will be locked for some time and it will be impossible to resell them even if you see the price going up. Once a certain low has been reached, that is where the managers disappear without notice extorting the funds invested by their clients.
In What Forms Do They Come?
The different types of scams can be divided into three main categories:
- Cash theft: this occurs when investors buy the tokens in question and the creators of the project steal everything from the pool of cash, which has the effect of drastically lowering the price of the token.
- Limit sell orders: this process consists of adding lines of code that prevent investors from selling some or all of their tokens. Only managers can do that. They wait for the price to rise and liquidate their positions.
- Pump-and-Dump: this method consists of manipulating the price of a crypto before selling its tokens to the highest and making the most of it. Quite often, a hype is created around the crypto in question to push investors to put their money in it. It is common to find celebrities encouraging their followers to invest in a particular project.
How To Avoid Falling Into The Backboard
No one is immune to a rug pull, however several indicators can help us minimize the risks. You should find out about the team behind the project and their credibility. Projects that come out of nowhere with anonymous developers are a line not to cross. It is also important to consult the white paper of the project. A lot of information may be missing and some will possibly be copied from other already established projects. It is just as common to see spelling and grammar errors.
The total token supply as well as its distribution should be of great interest to you. Between 10% to 40% of the market capitalization must constitute the trading volume so that you can trade your tokens according to your good will.In smart contracts, the project liquidity must be locked to prevent it from being emptied into its entirety at any time. A low TVL increases the chances of being scammed.
It is also necessary to exclude projects with a sudden increase in the price and those with promises of disproportionate returns. Affiliate marketing is often used by promising you commissions on the new users that you bring to their network and also those that they will bring later.
According to the latest report from Chainalysis, the number of victims of cryptocurrency scams has increased by just over 48% compared to last year. A sign that proves that it is more than necessary to be careful when it comes to investing in a promising project.