Crypto Rug Pull: What Is It And How to Avoid?

What is a crypto rug pull?

In cryptocurrency, a rug pull is a form of scam where a team artificially inflates the price of their token before disappearing with the funds, leaving investors with a worthless asset. 

What are the various types of rug pulls?

There are three main types of rug pulls: liquidity stealing, limiting sell orders, and dumping. Liquidity stealing occurs when token creators withdraw all the coins from the liquidity pool, whereas limiting sell orders is when developers code tokens to be the only party that can sell them. Dumping occurs when developers quickly sell off their own large supply of tokens. 

Rug pulls can be hard or soft, depending on whether malicious code or asset dumping is involved. 

Are crypto rug pulls illegal? 

While crypto rug pulls are not always illegal, they are always unethical. Hard rug pulls are illegal, while soft rug pulls may not be illegal but are still unethical. 

The collapse of the Turkish cryptocurrency exchange Thodex is one of the biggest examples of a rug pull in crypto, with the whereabouts of the alleged perpetrator still unknown. Other recent examples of protocols that have suffered this type of crypto rug pull include Meerkat Finance, AnubisDAO, Compounder Finance, and Uranium Finance.

How to avoid a crypto rug pull?

To avoid a rug pull in crypto, investors should be aware of certain warning signs, such as no liquidity lock or external audit. Here are 6 signs to watch out for:

1. Unknown or anonymous developers: Investors should consider the credibility of the people behind new crypto projects and be skeptical of easily faked social media accounts and profiles.
2. No liquidity locked: A legitimate cryptocurrency should have a liquidity lock on the token supply through time-locked smart contracts lasting three to five years.
3. Limits on sell orders: A token with selling restrictions coded in can be a scam project, and investors can test this by purchasing a small amount and attempting to sell it immediately.
4. Skyrocketing price movement with limited token holders: Sudden massive price spikes for a new coin can be a sign of a pump-and-dump scheme, and investors should check the number of coin holders to avoid price manipulation.
5. Suspiciously high yields: High annual percentage yields (APY) can indicate a Ponzi scheme or equally high risk.
6. No external audit: It is now standard practice for new cryptocurrencies to undergo a formal code audit process conducted by a reputable third party, and investors should verify that an audit has taken place.

Spotting a crypto rug pull scam takes research and due diligence, as an estimated $7.7 billion was stolen from investors in rug pull cryptocurrency scams in 2021. Before investing in a new project, it’s essential to do one’s homework and be aware of the red flags.