A rug pull is a malicious maneuver in which developers of a cryptocurrency project suddenly abandon it and run off with the investor funds. The name comes from the idea of “pulling the rug out from under” investors, leaving them with worthless tokens. This scam is especially common in decentralized finance (DeFi) because the projects can be launched with minimal oversight and due diligence from a centralized party.
Common Types of Rug Pulls
There are a few key variations on this scam that target different parts of a project.
- Liquidity Stealing: This is the most common form. A scammer creates a new token and lists it on a decentralized exchange (DEX), providing a small amount of initial liquidity (a pool of the new token paired with a valuable asset like ETH or a stablecoin). Once investors add more funds to this pool, the scammer removes all the liquidity, leaving the investors with a token that cannot be sold or exchanged.
- Limiting Sell Orders: In this scam, malicious code is written into the token’s smart contract that prevents investors from selling the token while the developers can. The scammer drives up the price, sells their holdings, and then the token’s price plummets, leaving investors unable to exit the project.
- Dumping (Pump-and-Dump): This is similar to a classic stock market pump-and-dump. The scammer creates a token and uses aggressive marketing and social media hype to drive up its price. Once the price has reached its peak, the scammer sells off their large supply of tokens all at once, which floods the market and causes the price to crash.
Due Diligence to Avoid Rug Pulls
By conducting thorough due diligence, you can significantly reduce your risk of falling victim to a rug pull.
- Audit the Smart Contract: Legitimate projects will have their smart contracts audited by a reputable third-party security firm. An audit report confirms that the code is free of major vulnerabilities. If a project has not been audited or if the audit report is vague, that is a major red flag.
- Check for Liquidity Locks: A crucial step is to verify that the project’s liquidity is locked. A liquidity lock prevents developers from withdrawing the funds from a liquidity pool for a set period. Tools like Unicrypt and DxSale can be used to verify if and for how long liquidity is locked. A lack of a liquidity lock is a major red flag.
- Investigate the Team: While anonymity is common in crypto, it is a significant risk factor. Research the project team and look for publicly available information, such as their LinkedIn or GitHub profiles. Be wary of teams with anonymous members, AI-generated profile pictures, or a lack of verifiable history. A good rule of thumb is “No face, no funds.”
- Analyze the Tokenomics: Look at the token’s distribution. If a small number of wallets (especially the developer’s wallet) hold a large percentage of the total token supply, this indicates a high risk of a token dump. You can use blockchain explorers like Etherscan to view token holders.
- Be Wary of Unrealistic Promises: If a project promises extremely high, guaranteed returns (e.g., “100,000% APY”), it is most likely a scam. Sustainable yields are tied to a project’s real-world utility and not just to the minting of new tokens.
- Evaluate the Community and Communication: A strong, genuine community with open discussion is a positive sign. Look for red flags such as aggressive marketing from anonymous sources, bots in chat groups, or a tendency to ban community members who ask critical questions.
- Start Small: If you’re investing in a new and unproven project, only invest what you are willing to lose. It’s always best to assume a new project could be a rug pull and manage your risk accordingly.
This video explains the different types of rug pulls and provides practical examples and advice on how to spot them and stay safe.
