What Is a Rug Pull?

A rug pull is a situation in which the creator of a cryptocurrency, NFT, or some other digital asset solicits investments in their product or service and then abruptly abandons the project, disappears, and keeps the investors’ funds.

In essence, the investors thought they were standing on solid ground and getting involved in a legitimate undertaking only to have the rug pulled out from underneath them.

Rug pull scams have occurred in all corners of the crypto landscape, including in decentralized finance, non-fungible tokens, Web 3, and even the metaverse.

This space is prone to such scams for several reasons, including:

That said, a rug pull isn’t unique to the cryptocurrency space — that’s just the latest iteration of the scam — and doesn’t mean that crypto is unsafe.

Unscrupulous individuals have been running rug pull scams (sometimes called exit scams) on unsuspecting investors for decades before the internet and blockchain technology were even a thing.

That’s why it’s so important to learn as much as you can about the rug pull scam — it can happen anywhere — and keep a sharp, skeptical eye on any situation that involves your money.

Types of Rug Pull Scams

1) Malicious Code

Some scams have the potential for theft built right into their code. In this case, a project developer builds a backdoor into the system with the intent of withdrawing funds at a later date.

Malicious code can typically be rooted out when the developer makes the code public. If they refuse to do so, that could be a sign that something is fishy underneath.

2) Liquidity Stealing

Most digital assets have a liquidity pool built into the system. That liquidity pool is supposed to contain enough capital (typically fiat currency) to ensure that the program continues to run should participants want their money back to initiate large transactions.

With any digital asset, the potential exists that developers could withdraw large amounts of the project’s liquidity pool thereby removing all value from the injected currency and driving the price down to zero.

Liquidity stealing usually happens in a decentralized finance (DeFi) environment.

Most crypto projects have safeguards in place to prevent this type of scam, but, as mentioned in the previous section, it is possible for developers with malicious intent to build vulnerability into the base code so they can gain access to funds at any time.

3) Limiting Sell Orders

In a limiting sell order rug pull scam, the developer codes the digital asset in such a way that they are the only one who can initiate sales.

The developer then waits for participants to purchase the assets. Once the price gets high enough, the developer sells all of their holdings and leaves a worthless token behind.

4) Dumping

Dumping — also known as a pump-and-dump scheme — occurs when a developer purposefully hypes a coin’s value (usually on social media) in order to cause a sharp inflation spike in its value.

At the peak of the spike, the developer then quickly sells off their large supply of assets. With a flood of new coins or tokens back in the market, the price takes a dive and often leaves participants holding worthless digital assets.

Dumping is a gray area because the process could be a straight-up purposeful scam, or it could be a side effect of the volatile cryptocurrency market.

How to Protect Yourself Against a Rug Pull

Knowledge, planning, and control are essential if you want to avoid being the victim of any scam. In this section, we offer tips for protecting yourself against theft and fraud.

1) Do Your Own Research

Before getting involved in any digital project, be sure to do your own research. It can be tempting to jump on the bandwagon of an especially attractive coin or token, but this can be extremely dangerous if that hype proves to be false.

Take the time to thoroughly examine the details of the project, the team who developed it, and the blockchain itself before committing your hard-earned funds.

In a worst-case scenario, a developer may create a pseudonym to keep their identity anonymous and protect themself from accountability.

Checking their identities on social media and other sources is a good way to see if they interact with well-known names in the crypto space and have a legitimate list of followers.

2) Favor Established Projects

It can be hard to resist the urge to get in on the ground level, but it’s often safer to favor established projects when first getting involved with digital assets.

New projects have no way of proving their legitimacy and safety. Over time, though, they will build a track record of trust and accountability.

The rewards might not be as great as they would have been had you jumped in at the beginning, but the potential for complete and total loss won’t be as high.

Keep an eye out for projects that imitate the exact features of other established projects. This could be a signal that the asset may not be original, may not have long-term value for investors, and may be a scam.

3) Be Wary of Grand Claims

Any project that puts out grand claims should be taken with a grain of salt and should cause you to be wary.

Scammers make such grand claims because they need liquidity — lots of capital in their accounts — to perpetrate the scheme.

The promise of high returns drives more and more people to get involved and keeps the money coming in. Then, once they’ve got enough, the scammers withdraw the funds and disappear.

Not all grand claims are fraudulent, but it’s best to be wary of anyone promising the world before you do enough research to convince yourself that the project is legitimate.

4) Check Out the Established Exchanges

A good place to verify a digital asset is on an established exchange, like Binance.US. Large exchanges typically review a project’s assets before listing them for sale or trade on their platform.

While this is by no means an absolute guarantee of the asset’s quality or potential, it is another step in proving the legitimacy of the project.

Coupled with the other suggestions on this list, it’s another piece of armor you can use to protect yourself from scammers and unscrupulous developers.

5) Resist the Fear of Missing Out

Fear of missing out (FOMO) is often associated with the grand claims mentioned earlier.

We’ve all heard the stories of someone getting involved in Apple stock back in the early 2000s when the price was less than $0.50 per share and then riding the explosion up to its recent price of $145 per share. And we all want to be the one to whom that happens.

Cryptocurrencies have the potential for making that a reality. But scammers can use that desire and the fear of missing out on a good thing to part people from their money.

Mind-blowing returns — like the Apple example — do happen, but they are extremely rare and should not be the sole reason you get involved in a position that could result in a complete loss of funds.

6) Get to Know the Code

You don’t have to be a programmer to get to know the code on which a project rests. At the very least, take the time to understand how a product works before committing your funds to the project.

It’s also good to check if the project has been audited by an independent organization. Many legitimate DeFi projects will have their smart contracts and other digital assets audited to ensure that there are no bugs in the code.

This can be a promising sign, and reputable developers will often reference and “advertise” this fact themselves to establish their credentials.

That said, while it’s a good first step, it is not a guarantee that a developer won’t tamper with a digital asset down the line.

https://blog.binance.us/rug-pull/