Crypto Rug Pull: Everything to Know
By Beluga Research September 21, 2023
- A rug pull is a scam that involves developers suddenly abandoning a project, causing investors to see the digital assets they have acquired significantly depreciate
- Rug pulls damage the trust and integrity of a particular asset and the entire crypto ecosystem
- These have become more common over time, especially in the decentralized finance (DeFi) space
- Investors can mitigate the risk of a rug pull by conducting thorough research, checking audits and code reviews, monitoring community sentiment and diversifying investments
A cryptocurrency rug pull is a scam that involves developers suddenly abandoning a project, causing investors to see the digital assets they have acquired significantly depreciate in value. The phrase "rug pull" comes from the expression "to pull a rug out from under someone." A rug pull typically involves the development and initial coin offering (ICO) of a new cryptocurrency. A rug pull can also involve another type of digital asset like a non fungible token (NFT).
The concept of a rug pull existed in the world of traditional finance before the crypto ecosystem took shape. Yet the novelty of upstart coins and the wide array of options in the crypto ecosystem create opportunities for malicious actors to take advantage. Smart contracts can facilitate rug pulls because they make it difficult or impossible for investors to recover funds. The pseudoanonymity of the crypto ecosystem can obscure the identities of the malicious actors who perpetrate these scams. In addition, the minimal presence or complete absence of government regulation for the crypto ecosystem disadvantages governments that want to trace and punish malicious actors.
A Brief History
The first known rug pull in the crypto ecosystem was a 2018 incident involving the "FOMO3D" game, which was based on the Ethereum blockchain. The creators of the game executed an exit scam, which means they "exited" the project after receiving funds from investors through an initial coin offering. The creators of the game took approximately $11 million in Ether (ETH) from the investors. This incident highlighted the vulnerability of investors in decentralized projects and the need for increased due diligence.
Rug pulls have become more common since that point. In 2020, the DeFi sector experienced explosive growth. This attracted attention and investment, as well as malicious actors looking to exploit investors. Rug pulls are now more frequent occurrences. In addition, malicious actors up the stakes by encouraging investors to lay out more funds.
Crypto Rug Pull: Everything to Know
- Anatomy of a Rug Pull. Rug pulls tend to follow a similar pattern. A cryptocurrency project gains attention through marketing, promising high returns and innovative features. The creators set up liquidity pools. They encourage investors to provide liquidity or buy the platform's tokens. As the project gains momentum, the creators suddenly take action to decrease the liquidity of the coin. They drain the funds and abandon the project. This leaves investors with worthless tokens.
- Anonymous Team. There is often a lack of transparency about the identities and experience level of the team members. This should raise suspicions for investors. The vagueness of the venture reduces or eliminates accountability for those in charge.
- Unrealistic Promises. If team members promise great returns or use exaggerated marketing tactics, investors should approach projects with caution.
- Lack of Audits. Rigorous audits by reputable firms help ensure the security and legitimacy of a project. A project without audit reports that does not provide verifiable information is likely a risk.
- Unlocked Team Tokens. Often project creators hold a significant portion of the token supply. These tokens are not locked or subject to vesting schedules. Such circumstances increase the likelihood of a rug pull.
- Community Engagement. Active and transparent community engagement is crucial. Indicators of a lack of credibility include a project team that avoids answering questions or resolving concerns.
- Lack of regulation. Minimal or no regulations in the crypto ecosystem have contributed to the proliferation and increasing severity of rug pulls.
- Target inexperienced investors. Rug pulls tend to gravitate toward investors who are new to the crypto ecosystem or are unfamiliar with complex concepts like staking pools.
- May involve the same malicious actors. Platforms that are able to identify malicious actors can take steps to limit their postings on web forums. They can also limit their transactions or ban them from engaging in transactions altogether.
- Techniques to minimize damage include awareness campaigns and regulation. Platforms can support and develop campaigns that inform investors about scams. They can also work with governments to explain which regulations are appropriate. The idea is to help identify and enforce penalties without jeopardizing other users' investment opportunities.
- Typically occur in decentralized finance (DeFi) projects. Often a rug pull involves scammers developing a seemingly promising DeFi project with an attractive website, social media presence and dedicated community.
- Investors left with worthless assets. Investors who have been defrauded can voice their concerns to their national governments. They can work with investigators to trace the malicious actors.
- Sharing lessons learned. Defrauded investors can explain to new users exactly how the scam occurred and what to look for in future projects.
- Transparency. Blockchain transparency exposes rug pulls by identifying suspicious activities. This alerts the community that there are concerns about the team in charge of the project.
- Community Vigilance. The crypto community should work to actively detect and report rug pulls. This will protect all members and promote information sharing and careful research.
- Learning Opportunity. Rug pulls educate investors about researching before investing. Such incidents help them understand the risks of investing in the crypto ecosystem.
- Market Maturity. Rug pulls make the cryptocurrency market more mature. Developers and investors become more vigilant. They understand and advocate for measures and regulations that will protect the market.
- Innovation in Security Measures. Rug pulls drive the development of enhanced security measures. They encourage stricter due diligence and better investor protection mechanisms.
- Investor Awareness. Rug pulls emphasize the need for investor education, skepticism towards high returns and thorough assessments of project credibility.
- Financial Losses. Rug pulls can cause significant financial losses. Affected cryptocurrencies' value plummets, leaving investors unable to recover their initial investment.
- Damage to Trust. Rug pulls erode trust within the crypto community. They undermine confidence in the market and hinder the success of legitimate projects.
- Negative Perception. A rug pull reinforces the negative perception of cryptocurrencies. They suggest that cryptocurrencies are associated with fraud and impede widespread adoption.
- Regulatory Scrutiny. Rug pulls attract regulatory intervention. This leads to stricter regulations aimed at protecting investors. Excessive and poorly designed regulations tend to hinder industry growth.
- Damage to Project Reputation. Rug pulls tarnish the reputation of the project involved. They affect the entire team and community. This makes it difficult for non-malicious actors and investors to recover and restore trust.
- Psychological Impact. Rug pulls have a severe psychological impact on victims. They cause investors who have been negatively affected to suffer emotional distress and express reluctance about investing in the crypto ecosystem.