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What is a rug pull in crypto 

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Cryptocurrency is the latest branch of finance, and its particularly attractive because of its ability to give extremely high returns in very short amounts of time. This makes the cryptocurrency space a target for scammers all over the world. In 2021 alone, a whopping $7.8 billion was stolen from the crypto industry. We will explain how rug pulls work, the different types of rug pull, and some real-life examples of rug pull scams. Finally, we will look at how you can spot a crypto rug pull.

Scammers stole most of that money from the decentralized finance industry or defi. With all the clamor to invest in the latest cryptocurrency, how can you ensure you don’t fall victim to the multitude of crypto scams out there?

That’s what today’s video is all about. We will take you through what many consider the most common scam in the crypto industry: rug pulls.

What is a rug pull in cryptocurrency?

Rug pulls simply mean crypto projects that are used to defraud investors. A rug pull refers to a situation where a project’s developers get investors to finance their project. Then dump the project after taking as much money as possible from the project. The result is that investors are left with a worthless project after losing their money.

By abandoning the project for investors, the developers essentially pull the rug out from under the investors. Rug pulls are a very common type of scam in the crypto industry. And that’s because they are quite easy to pull off.

Rug pulls are more common in Decentralized finance. As some of you might know, DeFi represents traditional finance services like lending, borrowing, trading, etc., done through decentralized technology. One common aspect of Defi is Decentralized exchange(DEX). This is a regular exchange like Coinbase or Binance, only decentralized. Examples of DEXs include SushiSwap, MinSwap, ADAX, etc.

So why am I telling you about DEXs? Because understanding what they are will help you understand how most rug pulls work. But first, let’s look at the different types of Rug Pulls.

What are the various types of rug pulls?

There are two main types of rug pulls, and they both depend on how they are executed.

Hard pulls vs. soft pulls

Hard pulls are more direct than soft pulls. In a hard pull, the developers usually alter the token’s code. This alteration can also be seen as a malicious backdoor. These malicious backdoors enable the developers to mess with smart contracts and steal funds.

A great example of a hard pull is liquidity stealing. This is when the token creators empty the liquidity pool of a coin. This causes the token to lose value. Sometimes, the token loses its value, and its price drops to zero. To pull off this scam, the creators pair an altcoin with a popular cryptocurrency like bitcoin or Ethereum. The pairing is for trading purposes.

The creators then go about generating hype for their currency pair. This gets people to start buying the token. As more people buy, the liquidity of the token goes up. As liquidity increases and transactions are locked in the pool, the creators get ready to ditch the project. Once they feel like they have enough liquidity, they jump ship, leaving investors with a worthless token.

Another popular example of a Hard Pull is limits on sell orders. The developers design the token’s code so that only they can sell it. Then,  they wait for investors to buy their tokens via a currency pairing. After stealing enough investor money, the developers abandon the project.

The other type of rug pull is a soft pull. These scams are called soft pulls because they are not always illegal. Of course, they are always wrong, but sometimes, this kind of deceit is not enough to be considered a crime.

The most common type of soft pull is the pump and dump. A Pump and dump refers to a case where the developers get a lot of market hype around their project. This causes the price to go up as people buy the token. The market hype then creates FOMO, which leads to more people buying the token. This, in turn, continues to increase the price of the token.

Once the developers feel they’ve made enough money, they dump their holdings. The huge sell-off triggers a negative price action for the token. Investors then watch as the value of their holdings become worthless. As we said earlier, this scam is wrong but not necessarily a crime. So it’s very easy for people to try to pull off pump and dump scams.

Real-life examples of rug pulls

One of the most common Rug pulls in recent times is Squid token. This token was created after the hit TV series Squid game. Like regular rug pulls, market hype built around Squid token very fast. A few weeks from its launch, the token went from one cent to $3.36, recording a gain of 33,600%.

If you think that was crazy enough, then the rest of this story will shock you. From $3.36, this token increased to $2861. All this within a few weeks. At this point, everyone was rushing to buy the coin. The “pump” had worked. And then came the dump. One day, the world woke up, and Squid token no longer existed.

The token was taken down while its promoters ghosted everyone. The coin’s price fell to $0.003. Over 40,000 individuals lost their money to this scam. Even worse, the holders of this coin can’t sell the token thanks to an anti-dumping function coded into it. Another famous rug pull is Luna Yield. Luna Yield started as a liquidity farming project for ecology. The project was running on Solana.

The project had gained over $2 billion in total locked value, and investors had put a lot of faith into it. Unfortunately, the project turned out to be a scam. The team behind the project deleted all their media accounts and cashed out $10 million from the liquidity pool. Many investors lost millions of dollars in the Luna Yield scam.

The last and probably the most famous rug pull is Thodex. Thodex was a centralized Turkish exchange that had been in operation since 2017. The exchange was centralized and was also KYC compliant. This gave investors a lot of faith in the exchange. As a result, the exchange had almost 400,000 users. One day, the exchange shut down its customer care channels and all its media accounts.

Investors were unable to access their money. Five days later, it was announced that the creator had fled with Turkey with about $21 million in investor money. Police have arrested 21 people in connection with the scam, although the CEO has been hiding ever since.

There are reports that the culprits could face up to 40 thousand years in prison if found guilty. That sounds harsh, but I’m sure their victims would disagree.

Are crypto rug pulls illegal?

Not all rug pulls are illegal. Most hard pulls are illegal, while soft pulls might not be illegal. This is down to the fact that the crypto industry is still very unregulated.

How to avoid a rug pull in crypto?

So now that we have seen the different types of rug pulls, how can we prevent them? The following are some tell-tale signs of a rug pull.

Developers are anonymous

One common feature of the cryptocurrency world is anonymity. The development team behind bitcoin remains anonymous. Sadly, this anonymity encourages scammers to carry out a lot of rug pulls.

Usually, such projects will have no information on the developers. No pictures or background information. Sometimes, they might have scanty information on the developers. But none that you can independently verify. Also, be careful as it’s easy to fake background information on a website or social media.

Make sure you stay clear of projects with an anonymous team behind them. Research the community behind a project thoroughly. Check whether they are known in the crypto community. Also, go through their white paper thoroughly.

Huge price gains in a short time(new projects)

Always be careful of new tokens that get a huge price increase in a short period. Such price gains are usually the first stage of the rug pull – the pump. The sudden increase entices others to buy the coin since they believe the price will keep going up, and they don’t want to miss out.

A great way to check whether a coin is legit is to check the number of people that own the coin. When a small number of people control the majority of a token, it will be easier to manipulate the price of that token. These few majority coin holders can sell off their holdings and send the coin’s price tanking.

Limits placed on sell orders

Another great way to spot a rug pull is to see whether they are restrictions on selling the token. Such tokens make it impossible for you to sell your holdings until the rug pull has been completed.

It can be difficult to find selling restrictions in the code of a project unless you are a software engineer with experience in blockchain technology.

A great way to look for selling restrictions is to buy only a small amount of the token and then sell it immediately. If you cannot sell the token, then there are high chances that you are dealing with a rug pull.

Zero liquidity locked

Legitimate cryptocurrencies lock an amount of liquidity in a time-locked smart contract.

This gives investors confidence in the cryptocurrency. It also prevents developers from cashing in on the liquidity from exchanges, so it makes sense that you should stay away from projects without any locked liquidity.

Developers can choose to lock the value themselves via custom scripts. However, it is better to go with projects that use third-party lockers for locking liquidity.

Furthermore, the percentage of value locked also matters a lot. This is called the total value locked. A safe project would generally have its Total Value Locked between 80% and 100%

Lack of external audit

Due to the high number of crypto scams, it has become standard for cryptos to get audited by a third party. Don’t rely on the development team’s claim that the token has been audited. They can easily be lying. So it’s better to rely on an audit report from a certified third-party auditor. Looking for the audit report of a cryptocurrency is especially useful in defi space because of its proneness to scams and rug pulls.

Yields that look too good to be true

One reason why it’s so easy to pull off rug pulls is because of human greed. It’s very common to see tokens that offer incredibly high yields on investment – sometimes in triple digits. These deals are so lucrative that the average person will be tempted by greed. Sadly, it’s the same greed that leads to the loss of money.

When approaching crypto investments, know that the higher the annual percentage yield(APY), the riskier a token or project. Make sure to stay away from investments like that because they often become scams.

So should you still invest in cryptocurrency, given the high number of rug pulls? Well, that depends. Even though rug pulls are common, most cryptocurrency transactions are legit. And many of them still give very high returns. That being said, you should keep your eyes peeled. Otherwise, you might fall victim to projects like Thodex or Squid token.

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