Learn Cryptocurrency
4 Mar 2022

What is a Rug Pull, and How Not to Let it Pull the Rug From Under Your Feet?

Ananda Banerjee

Remember the (in)famous Frosties project? Despite its 8,888 Non-Fungible Tokens and a truckload of artistic possibilities, the developers left investors high and dry on 10 January 2022—the day when they wiped out the cumulative token value of the project.

This was unfortunately not a one-off incident. It was the only first “Rug Pull” of 2022. Rug pulls are both way more common and devastating than you can even imagine. But what are they exactly, and how can we safeguard ourselves from them? Let’s find out.

Key Takeaways

  • A “Rug Pull” is a sketchy maneuver of a crypto project developer aimed at ripping off unwitting investors.
  • They can be either Hard or Soft pulls.
  • While not always illegal, they are always unethical.
  • Liquidity theft, restricted selling, and abrupt token dumping are different types of rug pulls.
  • To protect yourself, always prefer projects that have been audited extensively by credible third-party auditors.
  • Avoid projects with multiple whale wallets, hidden burn wallets, and unlocked liquidity pools.

The crypto realm is stacked with scammers. The kind of scammers that go beyond exchange and protocol hacks.

Unlike a malicious attack on exchanges where hackers steal millions worth of funds, rug pulls are more abrupt. And the effects of a rug pull are permanent. And if a “rug puller” scams you, there aren’t many ways to get your funds back.

Rug pulls are, unfortunately, more common than you think. And the endless number of new crypto and NFT projects being launched each day isn’t helping either.

In a world brimming with crypto-specific possibilities, the first thing to do is be aware—of rug pulls and other kinds of hacking and of the ways to evaluate the veracity of crypto projects.

Learning to call out the red flags in a project is what determines long-term success.

What is a Rug Pull?

A “Rug Pull” is a type of scam in crypto, where developers create projects only to lure investors and abandon them in time. Bad actors initiating rug pulls plan out everything, from the launch to token listing.

Once listed across credible exchanges—rug pulling involves price pumping—which in turn attracts investors in droves. Things move swimmingly. Tokens gain momentum. And then, all of a sudden, the project ceases to exist. All investors see is a wiped-out wallet.

Unlike crypto hacks driven by extrinsic agents and factors, a rug pull is all about the project vanishing overnight, intrinsically.

Simply put, they are akin to exit scams.

Types of Rug Pull

Are Rug Pulls Illegal?

As if the idea of getting the ‘rug pulled’ from underneath one’s feet isn’t bad enough, here is an interesting fact to supplement your frustration: A rug pull isn’t always illegal!

Before trying to grasp the legality of the matter, it will help to understand rug pulls—and the difference between hard and soft pulls—a bit better.

Hard Pull

This is a type of rug pull where the scam is ingrained within the project code. Malicious backdoors into the projects are created at the smart contract level. Such projects experiencing “hard” rug pulls are launched with fraudulent intent.

Soft Pull

A “soft” rug pull can be associated with an abrupt project dump. Investors are left “holding the bag”, as the project facilitators back out publicly.

So the answer to the question of legality is this: A hard rug pull is illegal. It concerns malicious coding and is purposefully phony. However, a soft one—albeit unethical— is not always illegal.

Dumping a project overnight can be traced back to personal and project-specific issues. Or it can be a crypto project going back on its promise of donating a set number of tokens made during fundraising. 

A soft pull is often a plan or attempt gone wrong. So project creators cannot always be prosecuted for the same—unlike a hard pull, where the plan is always to drain the investors.

How Do They Happen?

Before we get into the nitty-gritties of how rug pulls happen, we need to understand what a standard token listing and trading practice look like. It usually goes something like this:

  • Project developers usually list tokens on decentralized exchanges.
  • New tokens are added to a liquidity pool along with tokens that are already valuable, say Ether (ETH).
  • Once the liquidity pool is all set up, retail investors can trade the new tokens using the valuable tokens.
  • As the valuable tokens inside the liquidity pool increase, even the new token will start to gain value.

But once the new tokens have gained considerable value, malicious developers would initiate a rug pull. They do this by:

  • Pulling out the initial liquidity added by them to the liquidity pool;
  • Pulling out the new tokens that now have a significant value;
  • Selling out their massive share of token holdings before the retail investors get a whiff; or
  • Restricting retail investors from selling tokens by tweaking a piece of code while defining project protocols (more like a hard pull).

In the end, unwitting investors are left staring at an empty liquidity pool, some worthless tokens with excessive selling pushing the price to the nadir, and a wallet that is as good as empty.

Types of Rug Pull

Depending on the nature and extent of depravity, Rug Pulls can be segregated as follows:

Liquidity theft

This type of rug pull is also termed as “Yanking Liquidity.” It majorly involves withdrawing all the newly listed tokens from the liquidity pool, ensuring that value plummets. Liquidity thefts are common in DeFi ecosystems, where decentralized exchanges and liquidity pools can be created at will to facilitate trading. 

Restricted selling

Developers tweaking a chunk of project code to stop retail investors from selling their tokens in this type of rug pull. As the sell orders are limited for retail investors, the developers/project facilitators can sell their share of tokens at higher prices, but the former cannot let go of the plummeting tokens. So they are left holding the bag.

Fact Check: The “Squid Game” token developers restricted investors from selling even when the token clocked close to 45,000% gains. And then they rug pulled!

Rapid dumps

Dumping is the commonest rug pull technique. As the name suggests, developers quickly dump their tokens, often overnight, to spark a crash. Developer dumping is similar to the “pumping-and-dumping” of assets by whales.

Also, going by the book, dumping isn’t exactly illegal—like a soft pull. Developers can always buy and sell their own tokens. However, it is still unethical as investor holdings are reduced to peanuts. 

How To Spot the Red Flags and Protect Yourself

Rug pulls are devastating, so here are some tips to help you weed out sketchy projects. Only if you can spot a rug pull from a distance will you be able to avoid getting scammed.

Here are the best ways to spot and avoid rug pulls, regardless of the type:

Check for projects with locked liquidity

Unscrupulous developers often keep the liquidity pools unlocked. This way, they can run away with the tokens at any point in time. It is important to focus on projects that have locked liquidity managed by trusted third parties.

Locked liquidity is a positive indication. But you need to also keep a close eye and make sure that the liquidity remains locked, as the project price can be manipulated once the locked period expires.

Avoid projects with whale wallets

Always steer clear of crypto projects where only a few wallets—whale wallets—hold the majority of the new tokens. Blockchain explorers like BscSCan and ETHERSCAN can help you find the wallet-wise token concentration.

Whale wallets are a huge red flag; they show that the developers hold a sizable token supply volume. And that makes it easier for them to dump the same at any point.

How to identify rug pulls?

Check for the burn wallets

Some developers create “Burn Wallets” to hide whale holdings. What do we mean by that? Well, imagine a project has 1,000 tokens as total supply, and 900 of them are burned or sent to an inaccessible wallet. A burn wallet holding ten tokens now owns 10% of the circulating tokens but only 1% of the total tokens.

This lets the shady crypto project developers evade watchful blockchain explorers. Therefore, it is important to check the project white paper, token holdings, total supply, and everything else before proceeding.

Prefer audited projects

As a rule of thumb, avoid projects that haven’t been audited extensively. A credible crypto gig is one that has been audited multiple times by credible third-party patrons.

Look for a massive online presence.

Did you know that Bitcoin mentions on Twitter crossed the 6,00,000 mark on 02 March 2022? That’s the kind of social media popularity you want a crypto project to have before investing. Creating and listing a token on a DEX isn’t hard. What’s difficult for the rug pullers is to create a detailed, credible, and researched website and social presence.

Building credibility takes time and genuine effort. Something a scammy project won’t be able to relate to. 

Ensure the project uses multi-signature wallets

What happens when one of the developers associated with a project goes rogue and steals tokens from other developers’ wallets? This kind of unexpected and panic-inducing rug pull can be thwarted if developers relevant to the project use *multi-signature wallets.

*A Multi-Sig wallet is one that requires two or even more private keys to initiate a transaction.

DYOR

Watching out for the above-mentioned red flags is great, but it might not be enough. To protect your portfolio better, Do Your Own Research (DYOR)—extensively. With research, you can delve deeper into the founder details, problem-solving abilities of the project, tokenomics, and other insights.

Invest only what you can afford to lose

Even though research and looking out for red flags can help keep hard rug pulls to a minimum, there is nothing absolute to guard against soft pulls. Developers might get hacked, wallets might be compromised, or whales might end up selling all of their holdings, taking the token prices into the ground.

Therefore, you should consider diversifying your holdings. And only invest a sum you can afford to lose. Being aware of your financial obligations and responsibilities is always a good strategy.

Wrap-Up

In addition to everything else, always look for a credible centralized platform or exchange. Reliable trading platforms like CoinSwitch only list tokens after putting in days and months of research. And the groundwork, more often than not, ensures that the rug underneath you stays firm enough.

FAQs

Q1. What happens in a Rug Pull?

A1. Simply put, a rug pull is a scenario where developers associated with a particular crypto project make off after duping investors of their hard-earned money.

Q2. How can you spot a Rug Pull?

A2. A crypto project with unlocked liquidity, no audits, sketchy online visibility, and several whale accounts says a rug pull like no other.

Q3. Are Rug Pulls illegal?

A3. Not every Rug Pull is illegal. Some soft pulls, where whales sell-off or aggressively dump their holdings, are beyond prosecution. However, they are still unethical, considering the negative impact on investor holdings.

Are you planning to learn more about crypto and blockchain-specific concepts like these? Well, explore and read more at CoinSwitch & get ahead of the competition.

Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.

writer

Ananda Banerjee

Content Writer

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