Why Do Crypto Rug Pulls Happen in DeFi?

Published on:

Crypto rug pulls are a fairly common phenomenon in DeFi. But what are they, and why do they happen? Let’s look at some of the most prominent examples to understand why this has become a widespread issue. To start, let’s look at what makes a Crypto rug pull so appealing.

What Is a Crypto Rug Pull?

A crypto rug pull is a crime that involves the sale of cryptocurrency that has little to do with the coin itself. The project is often malicious and often uses a modified version of another coin to increase its value. Cryptocurrency has a decentralized nature and a lack of regulation, which makes it an attractive target for scammers and criminals.

A crypto rug pull can appear out of nowhere, but there are several signs to watch for. 

  • The first sign is that the project does not have a track record or an external audit. Secondly, the promoters are unlikely to be credible. Despite their claims, these projects usually fail to deliver on their promises.
  • Another warning sign is when an exchange shuts down without warning. In one of the most recent Crypto Rug Pulls, the OneCoin exchange shut down without notice, and its leaders swindled investors out of $4 billion. It has been labeled the largest fraud in history, and most leaders were arrested or disappeared. 

The OneCoin founder, Ruja, also disappeared without a trace. Most crypto rug pulls happen in decentralized finance systems with no centralized control and reporting requirements. The potential earnings from these projects can be quite attractive, but be careful and heed these warning signs!

Crypto rug pulls are a form of psychological manipulation that aims to inflate a token’s value by promising to give out free vouchers or promises to influencers. This type of fraud also makes it difficult to check the legitimacy of a cryptocurrency. A rug pull can also result in a decentralized exchange’s liquidity pool depleting and a token’s price plummeting.

How Does a Rug Pull Happen?

In DeFi, a rug pull can happen in one of three ways. First, developers can take your funds from the liquidity pool. This pool contains a new or established asset held in a smart contract. If the developer is malicious, they can program a “back door” into the smart contract to sell your funds.

This scheme can be avoided if you understand the basics of the cryptocurrency market. The rug pulls scheme pairs an altcoin with a popular cryptocurrency. Then, they copy the contract code of other tokens to increase the publicity of the altcoin. This process can also increase the liquidity of the token on the DEX.

In DeFi, the decentralized exchange determines the prices of tokens in a pool. It is essential to check the liquidity in each pool before investing. Most reputable projects lock in their pooled liquidity. In some cases, the prices of coins can skyrocket in a matter of hours. This is intentional and designed to create FOMO.

A crypto rug pull is a scam that involves tricking people into investing in a fake product. The scammers often create a token that has a low effort level. This causes many people to be fooled into investing, but the scammers disappear after a short time. The most common type of crypto rug pull occurs when a fraudulent project developer posts an altcoin on a decentralized exchange. The creator pairs it with another, better-performing cryptocurrency in the liquidity pool. Once a large enough amount of funds are invested in the altcoin, the scammers pull the rug.

Three Main Types of Crypto Rug Pulls

Crypto rug pulls can occur in many ways, with three main types of crypto rug pulls. One type is liquidity theft, where developers steal funds from the liquidity pool for a new or established asset. These funds are held in a smart contract, and malicious developers can program a “back door” into the smart contract to sell the extracted funds.

Another common type of crypto rug pulls is dumping. This type of scam is ethically grayer than the other types of crypto rug pulls since crypto developers are not forbidden from buying and selling their own currency. However, dumping involves the sale of an asset quickly and in large volumes.

Another type of crypto rug pull is called decentralized finance. In this space, there are no central intermediaries or regulators. Therefore, decentralized finance projects are prime targets for hackers. This makes them an attractive place for crypto scams. However, the benefits of these projects outweigh the risks.

Read more:  Bans on Paxos caused record cash outflows at Binance!

One method of identifying scam projects is by checking their TVL. The TVL represents the total amount invested in a particular crypto project. A legitimate project may have US$ 14 billion in TVL, while a scam project may only have a few thousand dollars. In addition, newer projects are more likely to be targeted by scammers.

Real Examples of Rug Pulls

Some key factors are to look for to distinguish a rug pull from a legitimate project. Luckily, automated contract scanners can help you figure this out. These scans look for contract functions that allow devs to mint coins, ban-list wallets from selling them, and change transaction taxes without limits. In addition, project liquidity isn’t locked for an extended period of time. There are some key signs that you can look for that will help you differentiate a rug pull from a legitimate project and what to do.

Luna Yield

Despite submitting the proper documents, the Luna Yield team’s fundraising has gone haywire. They’ve sent over 55 ETH to an address below, and there’s no way to trace it. As a result, they’ve canceled their website and social media accounts. No one has heard from them since.

While they’re not entirely scams, they’re a new type of scam. Developers create a project that looks legitimate but then steals investors’ funds. Once they have the money, they disappear. If you’re thinking about investing in a rug pull, stick with a project that has had its code audited. DEXs should require such audits before allowing projects to be listed. The $2.8B lost in rug-pull scams accounts for only the funds stolen and does not account for governance tokens.

Thodex

One of the first cryptocurrency exchanges to go bust was the Turkish-based exchange Thodex. In April 2021, the founders of this crypto exchange went missing with over $2 billion in client funds. Other failed projects included the dogecoin-inspired AnubisDAO and the Binance Smart Chain-based exchange Uranium Finance. Thodex was the only “centralized” rug pull of all the failed crypto exchanges. The rest fell into the decentralized finance category based on smart contracts.

In a recent investigation, the Anatolian Chief Public Prosecutor’s Office found evidence of a scam where a crypto exchange owner defrauded customers by using the crypto-money application Thodex. Twenty-one individuals were charged with Fraud and listed as complainants. The collapse of the Turkish cryptocurrency exchange, Thodex, resulted in the theft of over USD 2 billion and the largest centralized finance exit scam in history. The perpetrator is still at large.

Compounder Finance

Recent events in the crypto-asset space have shown the potential for scams on cryptocurrency exchanges. For example, Compounder Finance has been hacked and allegedly stole over $10 million in customer funds. The company substituted flawed contracts with fraudulent ones and even copied the name of the legitimate DeFi protocol. 

Rug pull scams are often easily recognizable by their extreme price increases. They involve a coin jumping in price dramatically, typically from 0 to fifty-fold within 24 hours.

The goal is to create FOMO and entice more investment. Compounder Finance developers stole over $10.8 million from investors in one such scam, stealing over 750,000 WBTC, $4.8 million ETH, $5 million DAI, and an assortment of other tokens. In addition, the scams have been exposed, and investors are wise to stay away from them.

Meerkat Finance

Meerkat Finance reported on March 4th that it had lost $31 million in a hack. The hack, which is believed to have been an exit scam and a rug pull, occurred after hackers altered the smart contract that was deployed by the project to steal investors’ money. The hack was carried out by using the account of the original deployer of the smart contract.

The project is run by developers who create a new token based on Ethereum’s ERC-20 standard but can use another layer one networks. This asset is then listed on a decentralized exchange known as a DEX.

Read more:  Crypto Wallets 2.0: Exploring Next-Generation Security Measures and Technologies

WhaleFarm

During the last few days, there have been real examples of rug pulls involving the decentralized exchange (DeFi) project WhaleFarm. The platform’s founders made big promises but failed to deliver, and a few days later, they were out of business. In the aftermath, the price of WhaleFarm’s native cryptocurrency dropped 100 percent, and many investors lost a great deal of money.

The WhaleFarm incident raised concerns about citrus projects in the crypto market. While investors could earn significant percentage returns, these projects also carry high risks. A rug pull, which involves a developer leaving abruptly and taking their investors’ money, is a scam. However, knowing the warning signs is possible to avoid a rug pull.

Signs That an Exit Scam and Rug Pull Is About to Happen

While the number of rug pulls and exit scams continue to rise, the amount of stolen money is decreasing. This is primarily due to more investors learning to recognize the common signs of an exit scam. For example, you should keep an eye out for excessive marketing tactics, yields that are too high, and the creator’s remaining anonymous. If any of these signs apply to your investment, you may want to stay away from it.

Yields Are Too High

There are several ways to identify a rug pull:

  • It is a low-effort project that is not genuine.
  • It is usually a modified version of another cryptocurrency.
  • It usually requires the use of a liquidity pool.

To make the currency tradeable, it must be backed by a legitimate currency. The most well-known rug pulls use a legitimate cryptocurrency.

Secondly, these fraudulent projects use the dexes as their liquidity pool. In this way, they can raise the price of their token by attracting more investment into the liquidity pool. Then, once the initial hype is over, they withdraw the ETH from the liquidity pool.

Creators Remain Anonymous

Exit scams and rug pulls are similar in that the creators of the schemes disappear with the funds that were transferred to them. They often happen on cryptocurrency exchanges, but most often on decentralized ones.

The scammers will create a crypto token, list it on a decentralized exchange, and then trade it at a profit when the value of the cryptocurrency increases.

naughtycrypto.io

To start a scam, scammers create a new cryptocurrency by registering it on a decentralized exchange, which does not require verification or audits. Creating a new coin is hard work, but scammers will copy code and edit the content of another coin to create a fake coin that will last only for a short time.

Coin Prices Skyrocket

One of the biggest warning signs of a rug pull is a coin’s price skyrocketing. This phenomenon happens when the creators of a coin withhold large amounts of the circulating supply just before it reaches its price apex and quickly sell off the supply, leaving investors with worthless tokens. This scenario is known as a pump-and-dump scheme.

A rug pull is a type of exit scam where a developer of a new cryptocurrency raises the price and then withdraws a large amount of their own ETH from the liquidity pool. This creates a false sense of security and investor confidence. These scams thrive on decentralized exchanges where users can list tokens for free and with little or no oversight.

Extensive Marketing Tactics

An exit scam and rug pull are similar in that both involve insiders taking your money and running. The only difference is that an exit scam is much smaller in value, but the value of the stolen money is much larger. A rug pull typically happens when a project or established entity shuts down, and the funds go with them. An excellent example is a DeFi project, SharkTron, which closed its website in November 2020.

No Liquidity Lockup

The most common example of a rug pull is a cryptocurrency exchange. These decentralized exchanges are not regulated, and listing tokens on these exchanges is free. As a result, malicious teams can easily dump a token if they aren’t audited. The problem with decentralized exchanges is that they can create a liquidity pool and dump a token with no value.

Read more:  Ethereum Staking Testnet Will Launch on Feb 1.

The best way to avoid falling victim to a rug pull scam is to avoid investing in projects with low liquidity. Tokens with low liquidity are hard to sell and can be subject to price manipulation. Even experienced crypto traders avoid these projects. You can check for this by looking at 24-hour trading volume.

How to Avoid a Crypto Rug Pull

When you’re ready to invest in a new crypto coin, you’ll want to ensure you’re not getting scammed. Some of the best ways to avoid crypto rug pulls are to avoid projects that don’t have a track record and to check the coin’s liquidity in question. You can review the project’s white paper and social media channels and look at its holders and listings on a DEX platform.

Check liquidity

To avoid becoming a victim of a crypto rug pull, you should check the liquidity of a particular token before investing in it. Liquidity is determined by decentralized exchanges (DEXs), which measure the price of a token against the total amount of available balances. The higher a token’s liquidity, the less likely it is to be a crypto rug pull.

You can check liquidity by using a tool that finds the contract address of a particular crypto asset. It’s also a good idea to check the team behind the project before investing. If the developers are anonymous, this can be a red flag. Another way to check the team’s legitimacy is by reviewing the project’s white paper. A legitimate project will publish a white paper that provides detailed information about its team and project.

Another helpful way to check the legitimacy of a crypto project is to see if the amount of invested funds in the project is higher than average. A project with over US$ 14 billion of TVL is likely to be legitimate, while a scam could only have a few thousand dollars.

Review GitHub Whitepaper and Social Media Channel

The best way to avoid a crypto rug pull is to research a project’s social media channel and Github whitepaper. The whitepaper should contain information that explains the problem the project is solving. You should also look at the project’s GitHub commit history to determine if the team has been active in the development and if the whitepaper is accurate.

Another thing to look for is if the project’s owners have relevant experience or industry connections. This project may be a scam if there are more questions than answers.

Cryptocurrency scams can appear out of nowhere. Often, these projects use a legitimate cryptocurrency as their model. The problem with this approach is that a legit project can take a long time to develop. Moreover, fake projects will be accompanied by plenty of hype. Some of them will try to cash in on popular memes to gain attention and money.

Confirm Team Credibility

The key to detecting a crypto rug pull is researching the project’s team and founder. While many legitimate projects operate anonymously, scammers use fake names and aliases. Besides checking social media and the company’s website, you should look for the project’s security audit details. Make sure that they have industry connections and relevant experience. If there are many unanswered questions, the project is likely a scam.

Look at Holders and Listings on DEX Platforms

Before investing in any crypto-asset, look at its listing and holders. Ideally, the listing should tie into the token’s description and the developers’ statements. Additionally, the project should tie into existing social media platforms and the team behind it. If it doesn’t, there’s a good chance that the project is just a fork of an existing one. Lastly, look at how many other platforms the token is listed on. It is best to avoid projects with only a few holders who are not active. This could be a sign of a scam.

Rug pull projects are a prime example. The developers of these projects don’t bother creating convincing public profiles and lack legitimate information. Instead, they’ll come out with a high-energy message, promising an exciting opportunity without solid details.

They may also spam social media accounts or use influencers to spread their message. If you see such behavior, block the account or unfollow the person.

Related