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What Is a Rug Pull In Crypto? | Beginner’s Guide

Omar A.

In this guide, you will learn about cryptocurrency-related rug pull scams. We’ll delve into what they are and why you should be knowledgeable about them to avoid becoming a victim. Also, we’ll highlight a few noteworthy examples of crypto rug pulls that have hit mainstream headlines to show and prove the consequences of such schemes.

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What is a crypto rug pull?

Adapting the general definition of a rug pull to crypto, the term thus means a sudden and deliberate withdrawal of support for a cryptocurrency project by its core development team. Whdrawal of liquidity from the project’s treasury or coffers often follows this action, thereby leaving investors exposed to losses.

It is often the case to witness a cryptocurrency token scam, but with the rising popularity of non-fungible tokens (NFTs) in the recent past, there have been a few incidents of NFT rug pulls as well. It is, therefore, important to understand both kinds so you can prepare yourself as an investor within the cryptocurrency industry.

Crypto rug pulls are more common within decentralized entities. These include decentralized finance (DeFi)  protocols and decentralized exchanges (DEXes) instead of more centralized properties. This is because decentralized entities have little to no adherence to regulatory provisions. Therefore, they encourage anonymity and pseudonymity amongst project developers and users alike.

According to a report by blockchain intelligence firm Chainalysis, cryptocurrency rug pulls alone accounted for a loss of $2.8 billion in 2021, which equates to an average daily loss of $7.67 million.

The good news for the wise and astute investor is that rug pull scams typically follow a similar path making them easy to identify and avoid. In a later section of this guide, you will learn these easily identifiable traits to look out for and protect your investments.

Recommended video: What is a Crypto Rug Pull?

Source: CoinMarketCap YouTube

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Types of crypto rug pulls

There are three common types of crypto rug pulls. These are:

  • Liquidity theft;
  • Limiting/blocking sell orders;
  • Token dumping.

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Let’s further discuss each of these three types of rug pulls.

1. Liquidity theft

Liquidity in cryptocurrency refers to the ease of conversion between two assets. It could either be a trade between a digital token and a fiat currency or another token. The easier it is, the higher the liquidity of the specific token.

A market is more liquid if there are large deposits of that asset held in a pool waiting for buyers or sellers. Alternatively, a platform could allow for direct trades between two market participants from their cryptocurrency wallets instead of trading from a pool. In this case, the more participants are trading a particular pair of assets, the higher the liquidity of this pair.

In cryptocurrency, typically, early adopters and project developers could opt to prop out the liquidity of their platform’s native token to make it easier for their communities to get access to it. The developers take up the responsibility of providing liquidity and maintaining a pool.

The pool, which typically comprises of two tokens, will allow traders to deposit one token in exchange for the other. In this case, if the project is new, a trader will deposit a popular asset such as Bitcoin (BTC) or Ethereum (ETH) in exchange for the pool’s token.

If the project is a scam, the team responsible for maintaining the pool would then withdraw from the pool, leaving investors with worthless tokens. This kind of rug pull scam is common within the DeFi space.

2. Limiting or blocking sell orders or withdrawals

In this kind of scam, the developers typically allow investors to buy their tokens but either limit or disable sell orders. They could limit sell orders right from the start of the investment period or much later when they are looking to lock in their spoils.

The rug pull of this kind is more common with trading platforms where scammers have access to the backend to enable and disable trades or withdrawals. This scam typically takes place on decentralized exchanges to minimize the chances of authorities tracking it.

Users of the exchange will be lured into using a new trading platform through an active marketing campaign. Once the exchange becomes abuzz with trading activity, the scammers will partially or entirely disable functionality.

For instance, it may still be possible to buy tokens but not sell them. Or, traders will be able to sell capped amounts. There are several versions of this scam, but the end goal for the scammers is to exit with the most amount of tokens.

It is also possible for developers to launch a smart contract for a crypto project with nefarious code that limits or prevents token transfers between wallets, thereby preventing owners of the token from selling it after acquiring it. This feature ensures that owners are unable to send the tokens to trading platforms for selling.

3. Token dumping

Token dumping is a more common practice that is arguably an unethical business practice. It entails token promoters pushing a particular token to the public to raise its price.

Investors will notice the meteoric rise of the token’s price and FOMO (fear of missing out) into the action, only for the promoters to dump their tokens into the market at the peak, leaving the latest buyers with overpriced tokens. This is what is commonly termed a ‘pump and dump scheme.’

A more subtle token dumping scheme happens where a nefarious crypto project team allocates itself a disproportionately large amount of the available tokens as compensation for their role. These token holders (also called whales) then dump these tokens in the marketplace immediately or after the lapse of a vesting period, thereby depressing the asset’s price.

Depending on how many tokens they hold and how many of these tokens they flood the market with, the price of the asset could fall significantly, resulting in losses for other token holders.

Examples of notable rug pulls in cryptocurrency

The following examples represent some of the highly publicized incidents in which investors lost a significant sum of money due to crypto rug pulls. Hopefully, once you have gone through the list, you will have a more concrete idea as to why rug pulls are a real threat to your investments. Additionally, these examples should serve as a wake-up call for you to be vigilant and better guard yourself and your capital.

1. Thodex Crypto Exchange

Thodex was a Turkish cryptocurrency exchange from 2017. The exchange managed to gain close to 390,000 active users as of April 2021, when it unexpectedly disabled withdrawals.

According to reports, the exchange shared a message with users alluding to a possible “outside investment” that may have necessitated its unusual behavior and asked them to stay patient for “five days” before the resumption of normal services.

It was later discovered to be a rug pull, with Fatih Ozer (CEO) making away with about $2.7 billion of users’ funds. According to reports from the Turkish Interior Ministry, he fled to Albania but was later arrested.

2. OneCoin

OneCoin represents one of the largest cryptocurrency-related Ponzi schemes in the history of the nascent industry. Founded in 2014 by Bulgarian Ruja Ignatova, the project purported to be a cryptocurrency company with a coin that could be mined and used for payments like Bitcoin.

In essence, the OneCoin blockchain did not exist, and neither could the coins be used to serve the purported use case. Instead, OneCoin was a classic multi-level marketing company selling courses on cryptocurrency investing and trading with incentives for buyers to introduce more buyers.

In March 2016, authorities in various countries started investigating the company, which saw Ignatova vanish into thin air, leaving her brother Konstantin Ignatov in charge. The authorities raided company offices in Bulgaria, arresting co-founder Sebastian Greenwood and later Konstantin, and charged them with, among other offenses, wire fraud, securities fraud, and conspiracy to commit money laundering.

All in all, OneCoin defrauded the public about $4 billion, and Ruja Ignatova is still missing.

3. Squid Game (SQUID) cryptocurrency

Squid Game (SQUID) was a controversial cryptocurrency project with an aim to take advantage of the popularity of the unrelated South Korean Netflix TV series that aired in 2021. The token, dubbed a ‘play-to-earn’ token, was created to reward users for their participation in online games. SQUID could, purportedly, be used to redeem points and exchanged for other cryptocurrencies.

The project attracted a lot of interest at its height leading to a meteoric rise of 40,000% rise at its peak. However, Squid Game token was a classic rug pull scam with multiple red flags, including the inability to sell these assets.

The promoters ended up with a horde of about $3.38 million and deleted their online presence, including all their social media pages and website. Following their exit, the token’s price plummeted by 99.99% before being delisted from the popular crypto analytics website CoinMarketCap.

4. AnubisDAO

AnubisDAO was a dog-themed cryptocurrency project which forked from the older OlympusDAO. The project came along during the dog-themed token craze of the second half of 2021, with the project conducting its crowdfunding in late October of the same year.

The team raised close to $60 million in less than 24 hours by selling the project’s native ANKH tokens for 13,597 ETH. With hours left to the close of the token sale, all these funds were transferred to an unknown wallet address.

Also, the ANKH/ETH liquidity pool was drained, leaving token holders with worthless tokens they could not immediately sell.

It is not clear whether the team carried out a rug pull or the smart contract contained a vulnerability that was exploited, but the project did exhibit all the telltale signs of a classic crypto rug pull.

How to avoid a crypto rug pull?

Rug pulls are frequent occurrences within the blockchain space, but they are often easy to identify. Most investors who fall for these scams typically portray a sense of ignorance and lack of initiative to protect themselves.

This section offers some of the most prevalent signs that a project could be a crypto or an nft rug pull in the making. If you identify these signs, it is advisable to keep off.

Team allocations

It is understandable for developers and project promoters to want to reward themselves for the work they undertake to bring a project to the market. However, the red flag is in the number of tokens they allocate to themselves.

Unusually large and disproportionate allocations are a giveaway sign that the team does not have the interests of the community at heart, and it’s worth digging deeper and getting confirmation to allay your suspicion.

To gauge whether an allocation is alarmingly large, check peers within the same niche and see what other founders are allocating to themselves.

Unlocked liquidity and lack of vesting periods

A common practice for most upcoming crypto projects are to lock the tokens allocated to the team to prevent dumping or even theft from the team members or hackers. If a project’s smart contract launches without the provision of a locking mechanism for the tokens, that is a red flag. There is little stopping the developers from taking their tokens and dumping them in the market as soon as they are able to.

Additionally, protections must be in place to guard a liquidity pool. If a project does not have these in place, walking away is advisable.

Lack of security audits

Auditing is essential, especially when done by an external and independent security firm. There are companies that provide these services within the blockchain space; therefore, there is no reason a project should launch to the public without undergoing a security audit for all aspects of its infrastructure.

The audit report should be publicized before the launch. And if there are any identified critical vulnerabilities, they need fixing before the launch.

Coupled with the security audit, it is important for the project team to avail the back-end code for the public. This way, potential investors who also understand the coding language can invest in auditing the code independently. Most projects opt to crowdsource and store their smart contract files on GitHub for easy access.

Unknown or anonymous promoters

By itself, this factor does not make a project a possible rug-pull scam. However, if it is one of the several red flags, it gains weight and becomes hard to ignore.

Knowing the identity of the team behind a project gives investors extra confidence to support the startup. It is, however, possible for a project to run effectively with little to no knowledge of those promoting it. A case in point is Bitcoin, whose creator(s) is still unknown more than a decade later.

Limited features

In the examples section above, we highlighted the plight of the Squid Game token investors who were able to purchase SQUID but could not sell them. If you encounter a project, and prior investors are expressing frustration about selling tokens, consider it a red flag. This suggests the project might be a rug pull.

Developers can disable features like wallet transfers and cap transfer amounts based on the project’s nature.

You can detect feature limits by initially purchasing a small amount, testing, swapping, or selling it within the project. If you are unable to do any of that, walk away.

Final thoughts

Guarding against a rug pull requires a proactive approach. Scammers are constantly working on new ways to make away with your hard-earned money. Hence, it is your responsibility to educate yourself to better protect your investment.

Hopefully, this guide takes you closer to achieving that goal. You can identify crypto rug pulls by their nature to avoid them before it’s too late.

There are still several other kinds of scams out there. Before you invest your money, ensure you do your own research (DYOR).

Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.

FAQs about crypto rug pulls

What is a crypto rug pull?

A crypto rug pull is a deceptive maneuver in the cryptocurrency space where developers abandon a project, taking investor funds. It results in significant financial losses for those who had invested in the project.

What is an NFT rug pull?

An NFT rug pull is a scam in which creators of a non-fungible token (NFT) project suddenly withdraw liquidity. These scams cause financial losses for investors, as creators abandon the project, leaving NFT holders with worthless assets.

Are crypto rug pulls illegal?

Not all crypto rug pulls are illegal. Some are just unethical, while others are schemes to defraud investors. For instance, token dumping may cause negative effects on the market, but it is not illegal. On the other hand, liquidity theft is against the law in most jurisdictions.

Can crypto recover from a rug pull?

More often than not, it is impossible to recover as it depends on the kind of rug pull. If a rug pull was executed by an anonymous team, it makes it harder to recover funds. However, if the promoter is arrested, they could pay back their spoils.

How can you spot a rug pull?

Rug pulls leave a trail of clues for those keen enough to spot them. They include checking whether:

  • The development team has awarded itself a disproportionate amount of the tokens;
  • If the project has been audited by a reputable external security audit;
  • The code is publicly accessible for independent security researchers to audit;
  • Whether the team is anonymous or well-known;
  • The liquidity pool is locked and if the team’s tokens are vested.

How does a rug pull scam work?

A rug pull scam involves project creators suddenly withdrawing funds, leaving investors with worthless tokens and significant financial losses. Thus, research and caution are vital to avoid falling victim to such scams.

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Omar A.