The crypto and NFT space is full of absolutely amazing projects that are taking the cryptocurrency world by storm. It's normal to get super hyped by a new cryptocurrency project with undeniable potential or the thrilling play-to-earn crypto games released frequently.
But not all crypto projects are legit, and a new phenomenon has emerged in the crypto space: the rug pull. Today we'll look into rug pulls to understand what they are and how to distinguish established cryptocurrency projects from crypto rug pulls.
What is a rug pull?
Rug pulls are exit crypto scams that happen when the developers of new projects disappear with the money of unsuspecting investors. Rug pull scams don't happen that often on centralized exchanges, but they are pretty frequent on decentralized exchanges and with decentralized finance (DeFi) projects.
The scam involves creating new tokens and listing them on a decentralized exchange. Once the token is listed, the crypto developers create hype around it on social media accounts, create a Discord server and gather a community around the DeFi project.
The not-so-much reputable developers remove all liquidity from the pool once enough users have exchanged their Ethereum for the new token. At this point, the token's value swiftly falls to zero, leaving the early investors with a worthless currency.
Because any developer can publish a token on a DEX for free without being vetted, these scams thrive there. The buyer must find established projects and do his own research before buying into a new cryptocurrency project.
On the other hand, centralized exchanges typically take considerable measures to safeguard their customer base.
Types of rug pulls
In an "exit scam," developers make promises and then abruptly "leave" with investors' money. Some exit scams are illegal, while others are simply unethical, placing them in legal limbo. There are two main types of rug pulls, the hard rug pull and the soft rug pull. Let's take a closer look at them:
Limiting sell orders: This type of rug pull scam involves an ill-intended developer coding the tokens so that nobody else can sell the cryptocurrency. They list their tokens on a relatively small platform, as a large exchange usually reviews the digital assets more thoroughly before listing them, and they wait for investors to buy the new crypto using paired currencies. Once enough people have invested in the token, they dump their positions, rendering it worthless.
Liquidity stealing: This hard pull happens when developers withdraw large amounts of coins from the liquidity pool. By draining all the project liquidity, developers commit fraud by stealing investor funds and driving the token's price down to zero.
Dumping assets: The pump-and-dump scheme is a soft rug pull, and it usually happens when new project owners quickly sell their supply after inflating the coin's value. They create massive hype on Social media around the crypto or NFT project, making sure to attract many investors due to a seemingly fantastic quality or investment potential.
Once they sell their supply, the coin's value crashes, and investors are left with a worthless currency.
How to avoid getting rug pulled
You could watch out for a few things when considering investing in newer projects, but they can also apply when choosing established cryptocurrency projects.
Pick established projects
The best way to avoid a rug pull is to avoid new projects that haven't got the same scrutiny as more established cryptocurrencies. Of course, this could also mean you would have to be able to invest more money and possibly lose some great investment opportunities from less-known projects.
Check if the liquidity is locked
To identify a scam coin, check whether the liquidity is locked. If there is no liquidity lock on the token supply, the project creators could disappear with the liquidity at any time.
A project's liquidity can be secured through time-locked smart contracts that should last between three to five years from the initial coin offering.
As you know, smart contracts are agreements governed by computer software, not the legal system. If something goes wrong with these smart contracts, there is little recourse that can be taken.
Check the project's computer code audit
Usually, a project should undergo a formal audit process of its code done by a reputable third party. It should review assets and establish that there isn't anything malicious in the code.
You're probably dealing with a scam if you can't find any track record of such an audit.
Research the developers' identities
Always take into account human factors when it comes to cryptocurrency projects. Do a background check of the crypto developers and ensure you find the websites and references that establish their credentials. If their identity is hidden, and you discover other red flags, stay clear from such a project.
Notorious rug pulls
There are quite a few infamous rug pulls in the cryptocurrency world, and we're going to showcase a few of them right here:
We're not talking about the uber-popular Netflix series but about a rug pull project that banked on the series' popularity to launch a play-to-earn game and a new crypto token called SQUID.
The token's price rose from just a few cents to an astounding $3,000 per token in a few days. Then the developers pulled the rug, quickly bringing the pricing back to zero. The website has since been taken down, and the developers escaped with millions of dollars. Yikes!
Copyright © Squid Game
Neku Inu was a rug pull project that presented itself as this adorable crypto game for families and friends where users could earn USDT. Although the project seemed to have potential, users spotted red flags immediately.
The referral scheme was heavy, allowing users to earn more from referrals than the downlines. The withdrawal time would take up to two days and featured a 5% fee.
Copyright © Neku Inu
Snow Dog had gained much popularity on Social Media before deciding to purchase back tokens on a custom automated market maker rather than the decentralized exchanges it had initially traded on.
By the time investors could access the AMM, two wallets had already sold more than $10 million worth of SnowDog. Because these transactions took place before the AMM was made available to the public, the community later concluded that the new project had its rug pulled.
Copyright ©Snow Dog
Another project that left investors with empty hands was Luna Yield. It was supposed to be an ecological farming project on the Solana blockchain.
The project's developers abruptly removed their Twitter, Telegram, and website accounts while withdrawing millions of cash. The investors attempted to withdraw their unstaked assets when the social media profiles were deleted, but they were unsuccessful.
Copyright © Luna Yield
To conclude today's article, you should know that the money usually lost in a rug pull is never recovered, so you should always practice caution when researching new projects for investments.
The different cryptocurrency scams in the crypto sphere shouldn't scare you away from the industry altogether. After all, you wouldn't give up love entirely after experiencing a bad relationship, right? You must be aware of the risks and prepared to see any potential red flags from the beginning ( just like in a relationship).
If you stay vigilant and always informed, you'll be just fine!
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