Imagine this. You spot a new token on the market. It has a lot of hype, so you and a lot of others buy in, hoping that the devs can live up to it. Then the token’s value drops to zero, the devs are gone, the Discord server is silent, and you’re out a whole bunch of money.

You have just experienced a rug pull. In this article, we’ll go into what a rug pull is, how it works, and how to spot one before you buy in. Read on to learn how to protect your investments!

What Is A Rug Pull?

Before we go into rug pulls, let’s start with the concept of exit scams. An exit scam is a type of crypto scam where the organizers of a cryptocurrency hold an initial coin offering (ICO) to attract investments, only to disappear with the funds they raised.

A rug pull is a specific type of exit scam typically found in decentralized finance. During a rug pull, a token appears on a decentralized exchange (DEX) and attracts investors, who buy in and increase its value. The devs then drain the liquidity from the pool and run, leaving the token without any value and the investors with a worthless token. Recent examples are SQUID Token and the Frosties NFT collection.

It’s named that way because that’s how it feels – like you’ve just had the rug pulled out from under you. We’ll go into the specific process of a rug pull in a later section.

While rug pulls typically occur on decentralized exchanges, it’s not impossible for a rug pull to happen on a centralized exchange (CEX). However, CEXes usually have more rigorous requirements to apply. 

Since CEXes more usually comply with Know Your Customer and Anti-Money Laundering rules, they’re better at filtering out bad actors. DEXes are less stringent about auditing tokens, which makes it much easier for a fraudulent token to get on them.

As of 2021, rug pulls accounted for 37% of all scam revenue from cryptocurrencies. This is a major increase from 2020, when they made up just 1%. Not even NFTs are safe, as in the case of the Frosties collection.

The Progression Of A Rug Pull

A rug pull typically goes in this manner:

1. A coin appears on a DEX. Since coins on a DEX have to be paired with another cryptocurrency, the coin has a liquidity pool, consisting of the currency the coin is paired with and the coin itself. The devs are required to contribute this amount.
2. The coin’s appearance on a DEX is accompanied by a PR wave building up hype for the new coin to get investors’ attention. Unsuspecting investors buy in and add liquidity to the pool.
3. As more investors buy in, the coin’s value rises. Trading volume increases and puts lots of crypto into the liquidity pool. The word spreads, so more investors come in and increase the liquidity pool even more.
4. The rug pull occurs. The developers withdraw all the crypto in the liquidity pool, close all their social media accounts and websites, cut off all lines of communication, and disappear. The token holders left holding the bag have lost all their investments.

When done with NFTs, the progression is only a little different. An NFT collection gains attention, attracting buy-in and increasing prices. Then, the developers transfer all the funds in the collection’s wallet to other accounts and disappear.

A rug pull may be an extended scam or happen very quickly. For example, CryptoEats scammed half a million dollars in only minutes.

Common Signs Of A Rug Pull

There are a few ways you can check on crypto projects to see if it’s legit or if it’s a potential rug pull.

• Team credibility: Who are the founders, the development team? Do they have a track record, industry connections, social media accounts? Can you even see who’s behind the coin? Credible founders are good to invest in, while anonymous founders should be treated with caution.
• PR and hype: How much actual substance is there in the project, and how much hype? If it’s mostly empty promises with nothing substantial, pass.
• Unrealistic projections: How much are the devs or artists promising? What kind of targets and timeframes are they thinking? What sort of benefits are on offer?
• Project code: A good eye can spot signs of a potential rug pull in the code, and many project developers will make the code publicly available for transparency. If you can’t access the code, that’s a red flag.
• Buy only: If it’s easy to buy a token but near impossible to sell it, it’s a scam.
• Not the original artist: Check to see if they mint NFTs, and check to see if the NFTs on offer match what the original artist actually does.
• Too good to be true: If it feels too ambitious or hyped up, it’s a potential rug pull.

Whether you’re looking at crypto or NFTs, you can avoid a potential rug pull by paying attention to the signs. For a more thorough rundown of how to recognize NFT scams, check out this NFT Investing Masterclass.

The Frosties Scam

There’s no way to stop a rug pull unless you see it beforehand and don’t buy in to start with. There’s no requirement to disclose identities, so you may not even know who scammed you. And it’s entirely possible that the scammer isn’t even in the same country as you.

But it’s not all bad news. You may have heard of the Frosties NFT collection, which turned out to be a rug pull that scammed its buyers out of $1.1 million. Ethan Nguyen and Andre Llacuna, the two behind the scheme, were arrested and charged with conspiracy to commit wire fraud and conspiracy to commit money laundering. They have not yet gone to court, but each charge carries a maximum sentence of twenty years of prison time.

Conclusion

Rug pulls are a particular danger when you’re investing in crypto, but they’re also a danger you can avoid with a bit of knowledge and care. And even though they’re a danger now, some exchanges are seeing the value of security measures and Know Your Customer rules. It’s likely that rug pulls may become more difficult to execute in the future.

Invest with care, keep an eye out, and you won’t have the rug pulled out from under you.