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In the world of cryptocurrencies there are thousands of projects and new forms of investment are continuously being created. There is a large number of users who are dedicated to pursuing these new projects because they know that it is in the nascent projects where the great opportunities for huge returns arise.
But despite all the opportunities that cryptocurrencies offer, there are also risks, losses and traps that could wipe out our entire investment. In this world many people are looking for a way to make easy money even if it means ruining other small investors.
The world of decentralized finance, better known as DeFi, is one of the most prone to attacks and scams. As a result, many retail investors who delve into these platforms run the risk of being scammed due to poor knowledge or misinformation. One of the biggest risks in the DeFi world is the Rug Pull. In this article we will tell you all about this scam, how to identify it and above all, how to avoid it.
How does a Rug Pull work?
A Rug Pull is a kind of manipulation in the world of cryptocurrencies. This concept is what we would characterize as an investor scam. The phrase “rug pulling” refers exactly to the action of sudden loss of liquidity leading to a massive sell off by liquidity providers or investors looking to save their money. In this dead end scam, the liquidity pool of a decentralized exchange or DEX is emptied, leaving token holders unable to sell their tokens.
Simply put, a Rug Pull is when the owners and developers of a project abandon the project and run off with the investors’ money. These scams usually come camouflaged behind excuses such as there are bugs in the software and time is needed for repair, however it is the owners of the project who usually keep the money that the investors will never get back. As we have already mentioned above, carpet pulling is more frequent in the DeFi ecosystem and DEX (Decentralized Exchanges).
Many of the projects that end up becoming a Rug Pull work as follows: a new DeFi project emerges that features its own native token and the developers pair that token with other known tokens such as ETH, USDT or DAI. In the new project users are allowed to exchange their tokens for this new native token of the project which attracts many more investors through higher rewards to the trap. However, when the number of investors increases the developers abandon the project and abscond with all recognized cryptocurrencies and investors’ money. Thus, only scammed users and an empty project are left behind.
It is often very easy for such developers to create scam-oriented DeFi platforms. This is because these platforms allow them to create a token without auditing the amount that exists on the network. One of the most common chains for creating this type of scam is the Ethereum network, as it features ERC-20 standards that facilitate the creation of various tokens.
These scams are also associated with anonymous founders who own a large amount of tokens and sell them leaving the price at almost 0. It should be noted that not all Rug Pulls are fast and unexpected, some are slow.
Slow and almost undetectable Rug Pull
Rug Pulls that occur slowly are more difficult to detect. These take place when creators develop a legitimate looking coin without showing any further warning signs, yet the coins are distributed in large quantities in wallets to which only the creators have access.
When users start buying the cryptocurrencies the developers’ price increases. In turn the developers start selling the coins generating money. The rest of the users will keep buying and the developers will keep selling until their wallets are empty.
This type of Rug Pull is more difficult to detect but not impossible. We can achieve it through Etherscan or BscScan. Through these tools we can verify the amounts deposited in the wallets. In the case that many wallets hold the same percentage of tokens it is likely to be a Rug Pull.
How to identify a scam?
As with any attack or scam, there are ways to identify these types of projects and protect our investment before it is too late. Here are some ways to do so:
- Check the liquidity background of the project. This is a quick and easy way to know if we should trust the project and check the liquidity of the group we are investigating. The higher the liquidity, the stronger the project. However, this is not enough, we must also investigate who is behind the project.
- Research the history of the founders. It is extremely important to research the history of the founders of the project, since we should not blindly follow any founder of whom we know nothing. It is very common to follow projects just because they are earning higher returns, however, this mistake can cost us our investment. Before investing, we must have the answer to questions such as: Who is backing the project, or Is there any previous information about any problems in this regard?
- Sudden fluctuations in the cryptocurrency price. It is clear that a rise in prices is a good sign for investors, however, in this type of projects an explosion in the price of the token is not a good sign. This is called Coin Skyrocketing. So if we notice a sudden increase in the same day as a x50 or x100 it can be a trap to attract investors.
- High rewards. We must be careful with high rewards. There are usually many DeFi protocols that launch and start offering high rewards in their pools. This is because they need higher liquidity to run the scam. So when they advertise a 500% or 1000% return we should think clearly before agreeing to put our money there.