What is Rug Pull: 6 Ways Crypto Investors Can Identify It

What is a rug pull? It refers to a scam scheme where developers or teams of cryptocurrency projects suddenly abandon the project, disappearing with investors’ money. Such fraudulent activities have surged in the unregulated environment of decentralized finance (DeFi), posing risks even for experienced investors. So, how can you protect yourself from these scams? By understanding the essence of rug pulls and identifying warning signs early, you can significantly improve your investment decision-making.

What is a rug pull? Understanding the basics of crypto scams

A rug pull is like participating in an attractive game at a party. Many players join, big prizes are offered, and you get excited and invest your money to start. But just when you’re close to winning, the game organizer disappears with everyone’s funds—that’s what actually happens in the world of cryptocurrency.

The reason why crypto scams, especially rug pulls, are rampant is because the DeFi space is outside regulatory oversight. Individuals or developer groups create hype through social media to attract traders. As interest grows, investors buy tokens or invest in NFTs, pouring in funds. Then, the developers suddenly sell off their assets and vanish, leaving investors with worthless tokens.

This sudden withdrawal causes the token price to plummet, leading most investors to suffer significant losses.

6 warning signs to check before investing

Early detection of rug pull signs is the best defense against scams. Be sure to check these six points before investing.

1. Investigate the transparency of the development team

Thoroughly research the reputation and credibility of the people behind a new project. Whether the developers are known figures with a track record in the crypto world or unknown entities makes a big difference. Watch out for fake social media accounts, and evaluate the quality of the project’s website and whitepaper. Poor design or unnatural language (Japanese or native language) are key signals indicating potential scams.

2. Confirm liquidity lock mechanisms

The most effective way to distinguish trustworthy crypto projects from fraudulent ones is to verify if liquidity is locked (secured). Locked liquidity means that, via a smart contract, the crypto tokens cannot be moved for a certain period.

If liquidity isn’t locked, developers can withdraw all liquidity at any time. Trustworthy projects typically lock liquidity for 3 to 5 years after token issuance to protect investors.

3. Test the sale restrictions

Fraudulent code may prohibit certain investors from selling, allowing only scammers to liquidate. A simple way to verify this is to buy a small amount of the new coin and attempt to sell it immediately. If you cannot sell the token, it’s a strong warning sign that the project may be a scam.

4. Check owner concentration and price volatility

Be cautious of sudden price swings in new coins with unlocked liquidity. Typical scam crypto assets show rapid price surges followed by crashes.

Use a block explorer to check the number of token holders. If a few wallets hold large amounts of tokens, the structure is vulnerable to price manipulation.

5. Excessively high yields are suspicious

The saying “If it seems too good to be true, it probably is” applies to crypto investments as well. New tokens promising triple-digit annual yields (APY 100%+) may not be rug pulls but could be Ponzi schemes (fraudulent schemes that use new investors’ funds to pay existing investors).

Projects promising unrealistically high returns should be fundamentally questioned about their sustainability.

6. Confirm third-party audit certification

Check whether the crypto you’re planning to invest in has undergone code audits by reputable third-party firms. Claims by the development team that they “conducted an audit” are not trustworthy. It’s crucial to find out which auditing company performed the review and how reliable that company is.

Certifications from well-known auditors like SlowMist or CertiK significantly increase trustworthiness compared to projects without such verification.

How malicious scammers operate: dissecting the rug pull mechanism

In the crypto world, a rug pull is like opening an attractive stall in a busy street and then fleeing with buyers’ money. Scammers employ various tactics to execute these scams.

Hidden loopholes in smart contracts

Fraudulent developers embed secret functions into smart contracts. This allows them to fully control native tokens or directly steal investors’ cryptocurrencies.

Dumping tactics

Scammers rapidly sell off their holdings in the market. This massive sell-off causes the token’s value to crash, resulting in severe losses for other investors.

Pump-and-dump schemes

Scammers artificially inflate the price of digital assets (“pump”) and then sell their holdings at the high (“dump”). Ordinary investors usually suffer big losses at this timing.

Monopolizing sale rights

Scammers embed code that prohibits anyone except certain addresses from selling tokens. As a result, scammers can freely sell, while ordinary token holders are unable to sell, rendering their assets worthless.

Learning from real cases: some of the biggest scams in crypto history

Rug pull scams have been meticulously planned, often leveraging social media influencers to deceive many and lure investments. Let’s understand how these scams work through actual examples.

OneCoin—one of the largest crypto scams

Luja Ignatova, known as the “Queen of Cryptocurrency,” co-founded OneCoin in 2014, positioning it as a revolutionary digital currency. In reality, this project was a massive Ponzi scheme that defrauded investors worldwide of billions of dollars.

In 2017, Ignatova suddenly disappeared to evade authorities. Her whereabouts remain unknown. OneCoin is recorded as one of the biggest crypto frauds in history.

Squid Game—exploiting pop culture

In 2021, a project capitalized on the popularity of the Korean Netflix series “Squid Game.” Promoters marketed the native token “Squid Coin” as exclusive access to a play-to-earn (P2E) game.

Speculative enthusiasm soared, and the token’s value skyrocketed. However, the developers cashed out immediately after, disappearing from the project, leaving investors with nothing. The token’s price plummeted close to zero.

AnubisDAO—about $60 million stolen in hours

AnubisDAO launched as a decentralized autonomous organization (DAO), promising huge returns to investors. Within just a few hours of launch, it raised approximately $60 million.

But the project’s liquidity rapidly vanished, and the developers fled with investors’ funds. Social media accounts were deleted, the website went offline, and the community was left disappointed and angry.

Progress in legal regulation and investor protection

Worldwide law enforcement agencies are intensifying efforts to track rug pulls, classifying them as fraud, theft, or securities violations.

In most jurisdictions, rug pulls are illegal, with regulators like the U.S. Securities and Exchange Commission (SEC) and the UK’s Financial Conduct Authority (FCA) actively combating them. Individuals involved in rug pull scams face hefty fines, asset confiscation, and imprisonment.

However, the decentralized and often anonymous nature of crypto trading presents significant challenges for law enforcement. Victims often cannot identify the scammers, and assets cross borders, limiting legal recourse.

Nevertheless, efforts to improve regulatory frameworks continue. In May 2023, the European Union introduced the Markets in Crypto-Assets Regulation (MiCA), the world’s first comprehensive regulation aimed at overseeing crypto markets and protecting investors. As legislators deepen their understanding of cryptocurrencies, similar regulatory enhancements are expected in other regions.

Rug pulls are a tangible threat in the rapidly evolving crypto market, but with proper knowledge and vigilance, investors can protect their assets.