The blockchain industry is gaining widespread recognition daily with its ever-evolving innovations, and this sees coins like Bitcoin and Ethereum growing rapidly in market capitalization. However, the flood in the market also makes it a crucial area for hackers and scammers to operate. They adopt several means to achieve this, one of which is called “Rug Pull.”
Rug pulling is the most common way scammers employ to defraud crypto investors, especially around the DeFi sector, and leaves them with extreme losses. The prevalence is quite alarming, and most research linked this to the use of Decentralized Finance smart contracts to launder and hide funds.
The aftermath will lead to a drop in price and set back in the market for months. It’ll also leave investors with one question in mind—where to invest their capital.
In this piece, we will describe what this new and common scam method is, how it works and ways to avoid the crypto scam.
What is A Rug Pull?
A crypto rug pull is a maneuver that exists in Decentralized Finance, where crypto developers run away with investors’ money after abandoning a crypto project.
Think of it this way—you just recently got some cash, and you decide to invest in the newest and hottest cryptocurrency in the market without doing due diligence. All you want to do is invest in a low market cap cheap token with the potential to rise.
Fortunately, that happens, and the token rises for a while. You see your investment now five times your initial investment. Then one day, you woke up, and suddenly, the token’s value is less than what it was when you bought it. The crypto developers are unreachable, and you’ve lost all your money.
Chances are, you have been involved in a rug pull.
Rug Pull scams are not totally new, but they have been growing rapidly over the years. According to a CipherTrace report, DeFi rug pulls constituted up to 99% of crypto scams in 2020.
There are a few methods by which a crypto rug pull is carried out, and we will study all of them so that you can avoid getting scammed when trading or investing in crypto.
How are Rug Pulls Carried Out
There are three main ways a rug pull happens:
Whenever investors create a token, they have to create a way new investors can trade that token. To make that possible, they put up a portion of a valuable token and a portion of their totally worthless and newly minted token in a trading pool.
When this happens, new investors can trust them with a valuable token in exchange for the newly-minted token created by the developer. As time goes by and more investors invest in their worthless token, causing the value to go up, the developers can rug pull the token and pull out their initial liquidity.
This causes the developer to have more valuable tokens than they started with. The investors would be left with more worthless tokens in the liquidity pool, making it impossible for them to trade.
Tokens are worthless without many people investing in them and believing in their value. If a token developer can convince a large number of people that their new token will be the next big thing and sell them this idea, they can persuade them to buy a lot of it.
As usual, when the token goes up astronomically in value, due to a lot of people trading valuable tokens for it, the project developers can sell all of the tokens they gave themselves in the beginning and disappear, causing the value of the token to drop terribly. This method of rug pulling often happens slowly, so you don’t know that you are getting rug-pulled.
Removing The Ability of Investors to Sell
Developers can add code to the token, thereby making it impossible for investors to sell their tokens to the decentralized exchange. Since it is impossible to sell, the price keeps going up until the developer changes the code to allow only them to sell all the tokens they either gave themselves or bought when the price was low.
Examples of Rug Pulls: How It Looks Like
A recent example of crypto rug pulls happened in March 2021, when TurtleDex, a decentralized Binance Smart Chain protocol, drained 9000 BNB, approximately $2.5 million, and deleted their telegram, the official website, and the Twitter page. The liquidity of the tokens was pulled out, and the team made away with the money.
Before it happened, holders were warned of an imminent rug pull by a Twitter user named DeFi Stalker.
Another recent example is the Safe Heaven token that got rug pulled in July 2021
How to Avoid A Rug Pull
All hope is not lost. You can learn to identify rug pull scams and avoid them before you lose your valuable tokens.
● Find out if liquidity is locked with a trusted third party to ensure that the developer cannot yank out their liquidity. Ensure the liquidity is locked for an extended period, not just for two months.
● Find out if a few wallets have a large percentage of all the coins. You can use trusted third-party applications like BscScan to find this out. If this happens, those wallets most likely belong to a small group of people that intend to sell their coins when the price goes up.
● Find out if their tokens have been audited by a couple of trusted third-party security sources.
Recap and Final Thoughts
DeFi rug pulls crypto scams have grown in recent times; therefore, investors must do their due diligence before jumping to invest in any token. Do not let the Fear Of Missing Out (FOMO) or your lust for money drive you to invest in a worthless token that is bound to get rug-pulled.
Look at the signs of a fake token above and try to avoid scams that would make your crypto investing experience painful. Click here for more up-to-date news in the blockchain industry.
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