Without the regulation seen in other financial markets, crypto has a bad reputation for scams.
Without the regulation seen in other financial markets, crypto has a bad reputation for scams. Fake tokens, exit scams, Ponzi schemes and pump & dumps, there are numerous examples for all of them.
What Is a Rug Pull?
Rug pulls are a type of exit scam in the cryptocurrency industry where the developers of a new project abandon it, and run away with the funds of unsuspecting investors. Rug pulls are almost unheard of on centralized exchanges, but happen quite often in the DeFi world.
To successfully execute their scam, developers create a new token, and list it on a decentralized exchange. They create buzz around the token on social media, through organic content and (usually undisclosed) sponsored content on big accounts. When enough people have swapped their Ethereum for the new token, the developers remove all liquidity from the pool, after which the token value quickly drops to zero.
The unsuspecting investor is left with worthless tokens, while the developer team runs away with the Ethereum (or BNB, SOL, AVAX). These scams work well on DEXes, because they allow any developer to list a token for free, without any vetting — the responsibility falls to the buyer of the token. Centralized exchanges generally go to great lengths to protect their client base.
Users can protect themselves against these rug pulls by checking the liquidity in the pool of a token they are buying, and making sure the liquidity is locked for a certain period.
There are two other ways of “pulling the rug.” Firstly, a team can rug pull a project by selling all tokens they have on the open market. If there is insufficient buying interest, this too can send the token to zero quickly. Alternatively, a team can code the token contract in such a way that you will only be able to buy, but never sell (similar to the Squid Game token saga). This way, a team could simply sell their tokens to unsuspecting buyers who will never be able to recover their funds.
In short, a rug pull happens when the team behind the projects withdraws all liquidity or sells all tokens they have on the open market, sending the project to zero quickly. In some cases, rug pulls happen because the token is coded in such a way that you will never be able to sell.
Examples of Rug Pulls in the Past
Sadly, there are too many examples to list, but to name a few notorious rug pulls…
- SnowDog – Snowdog was a popular project on social media, until the project decided they would buy back tokens on a custom automated market maker, rather than the DEX it was originally trading on. When the investors finally were able to access the AMM, two wallets had already sold over 10 million dollars’ worth of SnowDog. The community later concluded that the project rug pulled, because these transactions took place before the AMM was made available to the public. Rugged!
- Squid Game Token – Back when the Netflix show Squid Game was the talk of the day, malicious crypto developers took to the DEXes to launch a token named after the project. In just a few days, the token went from mere cents to an astonishing three thousand dollars per token. The developers then decided to pull the rug, driving the prices back down to zero in mere minutes. Since then, the website has been deleted, and the team got away with millions of dollars.
Rug pulls are most common in bull markets, but always remain vigilant. Read this article to learn more about how to detect new rug pulls!
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