While the crypto world is a hotspot for opportunities, it comes with its scams. One such threat is a rug pull, a scam that can leave its victims with huge financial losses. By understanding this phenomenon, you can protect yourself when investing in cryptocurrencies.
Keep reading this article to comprehensively understand what a crypto rug pull is. By the time you are through with this guide, you will be able to identify and avoid possible rug pulls as you invest in crypto. Let’s get right into it!
KEY TAKEAWAYS:
- A crypto rug pull happens when developers abandon a project and run away with investors’ funds.
- The breakdown of how rug pulls happen includes token creation, liquidity pool setup, pump through hype, and a rug pull.
- Some red flags of a rug pull are unknown developers, no smart contracts audit, low liquidity, and centralized project control.
- You can avoid rug pulls by doing your research, checking the token’s liquidity, and looking for reliable audits.
What Is A Rug Pull?
A rug pull happens when developers abandon a project and run away with investors’ funds. It is more common in decentralized finance (DeFi) projects where liquidity pools are created to support the trading of a new token. The concept of this scam situation comes from the idea of “pulling the rug out from under someone” because investors are left with cryptocurrencies that have no value.
How Does It Work?
Rug pulls are one of the reasons some people do not trust cryptocurrency investments, especially with newer or less popular projects. Here is a breakdown of how it is done.
- Token creation: The scammers develop a new crypto token and market it with promises of high returns. They can also partner with popular projects while claiming that their altcoin is based on an innovative technology.
- Liquidity pool setup: Next, they set up a liquidity pool on DEXs like Uniswap and PancakeSwap. They then pair the new token with a valuable cryptocurrency like Ethereum (ETH) or Binance Coin (BNB).
- Pump through hype: The developers build hype around the project through social media and influencers. As more people buy the token, its price increases, thus making it appear like a legitimate and profitable investment.
- Rug pull: After gathering enough liquidity, the developers remove their liquidity from the pool, sell it off for valuable currency, and disappear. Thus, the investors are left with worthless tokens.
How to Spot a Possible Rug Pull
While rug pulls have grown to be more sophisticated, here are some red flags that can help you identify a potential scam before it is too late:
- Unknown developers: An anonymous group of developers is a huge red flag. When a project is not transparent, it is easy for bad actors to disappear without facing any legal consequences.
- Promises of unbelievable returns: You should be skeptical about a token that promises extremely high profits with little or no risk. These claims are often made to lure unsuspecting investors who want quick profit. As the good old saying goes, if it sounds too good to be true, it probably is.
- No smart contract audit: A legitimate project would usually undergo a third-party audit that ensures its smart contracts are secure and transparent. Thus, its absence means there is a likelihood of hidden vulnerabilities or malicious codes.
- Low liquidity: If a token has low liquidity, its developers can easily pull the rug. However, those with locked liquidity are often safer since the funds cannot be withdrawn until a certain period.
- Centralized project control: If the project’s developers own a major portion of the token and can modify its smart contracts at will, then you should run.
How to Avoid Rug Pulls
Now that you understand how to spot a possible rug pull let us examine some proactive ways to avoid them.
- Do your research: Before investing in a token, look up its team, goals, and roadmap. You can also check for community engagement because most legitimate projects have active communities where open discussions happen.
- Check the token’s liquidity: High liquidity and locked liquidity are signs of a trustworthy project.
- Examine the coin’s smart contracts: If you have some technical knowledge, it is advisable to go through the token’s smart contract. Look out for pointers that indicate how much control the developers have over the project.
- Look for reliable audits: Ensure that a credible third-party organization has audited the project you want to fund.
- Avoid fear of missing out (FOMO): Do not fall for any hype or sense of urgency around buying a token. This is because FOMO can cloud your judgment and lead to you making reckless investments. Always take your time to investigate thoroughly before putting in your money.
- Join reputable communities: Join active crypto communities in Reddit, Telegram, or Discord to have valuable insights on new projects. Other investors may have identified potential scammers and mentioned them on these channels.
- Use trustworthy exchanges: As much as possible, use well-established and regulated exchanges. This is because they usually have a more critical vetting process before listing new tokens.
Conclusion
Rug pulls can happen to anyone, whether you are a new investor or an experienced trader. However, if you follow the tips we have shared in this article, you can reduce the possibility of falling victim and stay safe. Remember, stay informed, remain cautious, and do not allow the temptation of quick profit to cloud your sense of judgment.
