What is a Rug Pull in Cryptocurrencies?

What is a Rug Pull in Cryptocurrencies?
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2021.11.13

Rug pull is a term used in the world of cryptocurrencies. Literally, rug pull is pulling the carpet. But in the crypto world, rug pulls have another meaning. It is a type of scam or deception where the developer abandons a project and takes all the money that investors have invested in his/her project.

The emergence of cryptocurrencies and blockchain, with the sudden surge of Bitcoin on the rise, opened up many investing avenues and opportunities. New industries with the crypto space are opening up, hence there are lots of new jobs and opportunities in this field. Because of the tremendous interest in this field, the speed of service is needed. This is one reason why the security and transparency of the project are often neglected and overlooked. This opened a new wave of fraudulent activity such as rug pulls.
 

Simple Definition of Rug Pull

When liquidity is lost(drained) suddenly by the project owner or the project core team members, it causes a huge loss in the project. At this point, none of the investors are able to trade or swap their tokens which causes a huge financial loss. This is a form of exit scamming where the developer will drain the DEX.
 

How Do Rug Pulls Work?

Rug pulls usually occur on decentralized exchanges (DEX). Developers will generate tokens and list them on a DEX, then intentionally pair them with popular cryptocurrencies like Ethereum or Binance Smart Chain. Usually, there will be investors, investing(buying) in those tokens.

After the desired amount is reached, the developers then withdraw all of them from the liquidity pool. As a result, the price of the listed coins hits zero. Investors who have already invested in that particular project now encounter a huge loss of their investment when this situation occurs. 

But why does this scenario happen? How can an investor blindly invest in a new project without doing proper research and due diligence or background check of the project owners?

To create a rug pull, developers can do anything. For example, they will create hype or sensation on social media such as Twitter or Telegram. It can also be on other social media. They then inject large amounts of liquid capital into their pool. By doing that, newbie investors will believe that the project is trustable and worth investing in.

 

Where does Rug Pull Occur?

Rug pulls generally occur on a DEX because new tokens generated can be easily registered for free and there is no need for an audit check. The process is not the same as a centralized cryptocurrency exchange. Exchanging BNB or ETH for newer coins on an open blockchain is easy and hassle-free. Because of these 2 factors, the developer takes advantage of the situation and treats it as an opportunity to Rug Pull.

As mentioned earlier, these fake and irresponsible developers will create hype and sensation on social media to gain attention. The modus of operation is usually by creating a group on Telegram and gathering as many potential investors as possible. In order for investors to be easily tricked or to believe in the soon-to-be Rug Pull project, they will register tokens that have similar names to existing popular projects. That way, these developers are able to get the attention of a wider group of investors.
 

Many Investors Have Lost Big

Every day there are many new coins that are been listed on the DEX. One of the most popular DEX is PancakeSwap. This DEX is known to accept any new coins to be listed without KYC or any project background check. For an experienced trader or a cryptocurrency investor/player, it may not be easy to trick or fool them. But for those who are new to the world of cryptocurrencies, these newbies will be happy to exchange their BNB or ETH with a new coin which promises an increase by 10 times sometimes 100 fold in just 24 hours.

Such investors usually believe in groups created by fake developers on social media. They usually believe that they had found the greatest gem or investment opportunity of their life. But in reality, they are about to encounter a huge loss.

On Twitter, the practice of rug pulls occurs regularly. An example is a new coin that imitates a name similar to Ampleforth (AMPL), which is called TRUAMPL (TMPL). A new TRUAMPL was created, and in 3 hours, after the desired amount had been collected, the developer did a rug pull. Ethereum as much as 1800 ETH was taken away in a wink of an eye.
 

How to Avoid Getting Hit by the Rug Pull Trick

Cryptocurrency investors must pay attention to the use case of the coin in which they are about to invest. Also, if the price of the token suddenly pumps within 24 hours, then there are high chances a Rug Pull might occur and that project should be carefully watched (better still – stay away from these kinds of projects). For example, the price of a coin changes from 0 to 50 times more in 24 hours. This trick is used to attract investors to be interested in the new coin. But don't be fooled by this kind of trick. Again, emotions play a vital role when investing in cryptocurrencies.

However, rug pull won’t happen in all projects. Most reputable and honest projects will lock in their liquidity. This liquidity is locked for a certain period of time. To avoid being Rug pulled, it is recommended that cryptocurrency investors always check the liquidity in the DEX pool. Also, try to choose a project that has a longer liquidity lock time frame.

In addition, it is recommended to do research on the coins which you’re about to invest in. For example, find out how marketing will be conducted, how are they acquiring new investors, who are the team behind the coin, what are the developers and core team members experience. Is the developer a credible developer or a new player? These are some of the questions which you as an investor have to ask and know before investing in a project. By going through some basic questions with the developer/project owner and core team members, you are able to minimize the risk of falling prey to a Rug Pull project.