The growth of the crypto space in the last few years remains remarkable despite pertinent public issues. Cryptocurrencies like Bitcoin have gone mainstream and remain utility assets even outside the crypto space. Unfortunately, the crypto ecosystem is not devoid of its vices, most of which have slowed down its adoption globally. While price volatility looks like the most significant issue in the crypto space, the rising cases of scams are alarming. Crypto scams are the most unfortunate events in the ecosystems, hindering the global adoption of cryptocurrencies. Over the years, the perpetrators of these acts have grown in numbers, adopting various methods of execution. From hacking, fake crypto investments, ICO frauds, and fake crypto wallets, these perpetrators continue to malign the crypto space growth. However, one of the most common scams today is the crypto rug pull, typical with new projects.
What Is A Rug Pull?
Rug pulls are scams pulled by cybercriminals, luring investors to committing funds to a project and disappear with the money. These cybercriminals disguised as crypto developers usually promote a new project or token to attract investors to themselves. Typically, the development team pumps the project’s token price to lure investors in a rug pull. The price will fall to zero after investors commit funds to it, with investors losing huge funds. This scam is one of the most popular in the crypto ecosystem, as investors have lost billions of dollars in them. According to Chainalysis, 37% of cryptocurrency scam revenue in 2021 ($2.8 billion) was lost to rug pull scams. Unfortunately, that was a massive leap from the 1% loss in 2020, a testament to how potent these scammers have become.
How Rug Pulls Scams Work
Rug pulls are the easiest to execute, and hence why they remain the most popular scams in the crypto ecosystem. Firstly, the disguised scammer will go to Ethereum or an alternate blockchain to create a new token. This token will also list on decentralized exchanges (DEXes) or peer-to-peer marketplaces for crypto traders. Most of the time, these tokens are without a code audit for external participants to assess them.
Code audits are vital to smart contracts to assess the code for errors, bugs, and quality standards set by the organization. Without a proper one in place, these developers can quickly introduce bugs to pull off this scam successfully. Unfortunately, smart contract networks like Ethereum allow developers to build these projects without a proper code audit. This is why investors might find it challenging to understand the technicalities around the project. Unfortunately, the prospect of making quick returns will easily becloud investors’ thoughts too.
Forms Of Rug Pull Execution (Hard Vs. Soft)
Typically, scammers can perpetuate rug pull scams in two different forms- hard and soft pulls. Hard rug pulls involve malicious coding backdoors into project codes by developers. These malicious codes into the project’s smart contracts are primarily pre-planned. Unfortunately, they are unknown to investors who will commit funds to the project later. The intention of these malicious backdoor by the developers is to commit fraud from the onset. Alternatively, soft rug pulls involve project developers dumping their assets immediately after getting enough investments. When this happens, the majority of the project investors possess a devalued token in their portfolio. Surprisingly, this rug pull is not considered criminal but rather unethical. Unfortunately, regardless of when it occurs, it usually leads to losses for most project investors.
Types Of Rug Pulls
The three most common types of rug pull in the crypto space are liquidity stealing, limiting sell orders, and dumping.
Liquidity Stealing
This is a dangerous hard rug pull scam whose aftermath will leave investors in huge losses at a glance. It occurs when project (token) creators withdraw all the coins from the liquidity pool. One consequence of this action is that the token’s value will drop to zero. Unfortunately, investors will also lose all their funds invested in the project when it happens. This rug pull is very common in the DeFi space and continues to limit the growth of the thriving financial space.
Limiting Sell Orders
This is a hard rug pull and a subtle way for malicious developers to defraud investors. This occurs when developers program the tokens so that only they can sell them. Project developers wait for retail investors to buy into their new crypto using paired currencies to execute it. Immediately they sight enough positive price action, they dump their positions and leave a worthless token. Many projects have pulled these scams in the past, with the most notable being the Squid Token scam. The project, inspired by Netflix’s original- Squid Games, posted gains of about 45,000% a few days after launching. Unfortunately, investors were not allowed to sell their assets.
Dumping
This soft rug pull scam is not considered criminal but unethical. It involves project developers owning an ample supply of tokens and selling them when prices go up. The effect of this is that the project investors end up with worthless tokens when dumping happens. Unfortunately, heavy promotions on social media impact this rug pull. However, there are numerous debates around this rug pull, as many do not see it as a crime. While opinions remain divided, major investors lose huge funds when dumping occurs, with few profiting. The resulting spike and sell-off are known as a Pump-and-Dump Scheme.
How To Avoid A Crypto Rug Pull
The collapse of the Thodex, a Turkish-based crypto exchange, remains one of the largest rug pull scams in history. The $2 billion theft in 2021 was one of the largest centralized finance (CeFi) exit scams in history. However, spotting a crypto rug pull scam is not easy, but one could get it right with the steps below;
Zero Liquidity Locked
An easy way to distinguish a scam token from a legitimate one is to check if the asset is liquidity locked. With no liquidity lock on the token supply, the project creators can run away with the entirety of the liquidity anytime. Typically, time-locked smart contracts, ranging from 3-5 years from the token’s ICO, help secure liquidity. However, developers can use bespoke time locks in some cases, which is not a bad option either. However, it is most comforting for investors to know that these liquidities locking is via a third party. Investors should also check the percentage of the liquidity locked, which should not be less than 80%.
Anonymous Developers
The type of project developers is a factor investors consider, as most anonymous project owners could end up as scammers. Surprisingly, Bitcoin’s founder- Satoshi Nakomoto, remains anonymous, and the project is also the largest in the crypto ecosystem. However, in today’s world, unknown developers should be red flags for investors. Investors should be able to decipher who project founders are, their track records, other existing projects (if any), etc. This will give more insights into what they are committing their funds into.
Limits On Sell Orders
If project developers limit sell orders, the project has a high chance of ending up as a rug pull. Investors may commit just little funds to these projects to lower their risk, especially in its early days. The problems with a limit on sell orders might not be scam-related, but there are high chances it is. However, If there are problems offloading new purchases, the project is likely to be a scam.
Suspicious Skyrocketing Price Movement
If a new token’s price is moving up fast, there are high chances it is a pump and dump scheme. Alternatively, it could also be a Ponzi scheme run by a few token holders. Investors skeptical about a coin’s price movement can use trackers to check the number of token holders. A small number of holders might indicate the token is open to price manipulation. This scenario could also mean that a few whales can dump their positions and do severe and immediate damage to the coin’s value. However, with a proper background check, investors can quickly discover this.
Lack Of External Auditing
It is now a standard practice for new cryptocurrencies to undergo a formal code audit process via a reputable third party. An audit is applicable for decentralized cryptocurrencies, where default auditing for DeFi projects is a must. This external auditing will give investors confidence in the project and can expose anomalies within the project to the public. Unfortunately, most projects do not possess integrity these days and may deceive investors that an audit has taken place. Investors should further verify their claims via a third party to confirm nothing malicious is in the code.
NFT Project In Rug Pulls?
Earlier in January, the launch of the Azuki collection took the NFT community by storm. Azuki features series of avatars with a distinct look with equal parts of The World Ends With You and Thrasher. After launching, the NFT project built up momentum to threaten top projects like the Bored Ape Yacht Club (BAYC). Unfortunately, the project took a nosedive this month when Zagabond, its founder, announced via Twitter that he had abandoned his earlier three projects. The announcement created a lot of fuss in the crypto community and penultimately crashed Azuki’s price from 19 ETH to 10 ETH. Unfortunately, most of the backlash centered around how Zagabond abandoned CryptoPhunks, Tendies, and CryptoZunks, profiting $3 million in two months. This abandonment by Zagabond is like a rug pull and poses as the first rug pull in the NFT ecosystem.
However, in Zagabond’s defense, he argued that everything he promised in the project was delivered. However, investors felt he didn’t consider them or their funds before dumping the project. Several Twitter users also accused Zagabond of rug pulling, with crypto analyst ZachXBT terming it multiple instances of negligence. ZachXBT sighted many issues around community engagement and ownership transfer around how Zagabond handled his previous projects. However, in another lengthy post and after denying the rug pull allegation, Zagabond apologized to investors who lost money in the project. The pseudonymous founder has now promised he will compensate them for all their losses. He also now clarifies he’ll be transferring ownership of those projects to the right hands. This entire Twitter crypto space were happy with the news.
Conclusion
In the future, NFT investors will be hoping rug pull scams continue to stay far from the thriving collectibles space. This will be important to its growth, public perception, and acceptance. The NFT ecosystem continues to grow in strength, particularly attracting non-crypto audiences. This is why its market capitalization continues to skyrocket amidst new projects. Furthermore, the determinants of its future will be dependent on the less negative media attraction it gets. However, aside from gas fees, the NFT ecosystem remains upright today.