Let’s say you’re a new investor, and you take your newly deposited Stemi and decide to go in on the latest and hottest cryptocurrency out there. Without knowing too much of the crypto sphere, you’re following what you see on social media and buying a low market cap cheap token.
You see your initial investment jump from 2Xto 3X, and then you see a 10X return, but when you check the following day, the price has dropped to almost zero, and you can’t understand why you lost so much money and why the token developers are leaving everyone on red.
This causes you never to want to trade cryptocurrency again. Well, you might have just been involved in an infamous rug pull.
Welcome to Shavuna, where we break down complex cryptocurrency topics into easy stories and examples so you can better understand them.
In this blog post, I will explain what a rug pull is.
What is a Rug Pull?
So, what exactly is a rug pull? A rug pull happens anytime the developer of a token or a coin runs away with the investor’s funds.
Let’s jump right in.
How Does a Rug Pull Happen?
There are three main ways that this happens.
- Yanking Liquidity.
If you haven’t already, you really need to read our article on liquidity pools. You’ll be able to understand the rest of this post as soon as you do.
So, whenever a developer creates a token, they must create a way for new investors to trade that token, and to do so, they put a portion of a valuable token and a portion of their newly minted worthless token.
Both of these go into a trading pull. This allows new investors to give them the valuable token, and in return, the investors will receive the newly minted developer token.
However, as time goes on, and as more investors invest and the price of the worthless token increases, the developer can rug pull the token by pulling out their initial liquidity.
By doing this, they don’t just get back the initial amount of worthless tokens and the valuable token that they originally put in due to how automated market makers work. You can read our article on that if you want to learn more.
There will actually be very little worthless token and a lot more of the valuable token. After they yank out the liquidity, they will essentially have a lot more of the valuable token than they started with. All the other investors will not be able to trade because the liquidity pool will literally have nothing in it to allow a trade to happen.
- Developer Selling Their Shares.
The second way a rug pull can happen is just by a developer selling their shares.
Essentially they created a worthless token. Anyone can create a worthless token. A token only has value if it does something or other people think it has value.
The developer might convince a large majority of people that their token has a promise.
For example, they might say that they have a new platform that’s releasing soon and when it does, it will be the next big blockchain plus something where that something could be eco-friendly tea, it could be not safe for work videos, it could be cat NFTs, it could be a super vast version of Bitcoin.
They promise something in the future, so they sell this idea to a ton of investors, and then when the price of the token is high, they sell all the tokens that they gave themselves during the start of the token launch.
In other words, what they did was they minted a worthless token got people to trade a valuable token for it like BNB or Ethereum and then ran away with the valuable token they convinced people to give them.
This method sometimes happens slowly over time so that you don’t think that you’re getting rug pulled, but others will often happen in a matter of minutes.
Inability to Sell
The third way a developer could rug pull is by removing your selling ability. Some token creators can clearly add some code to their token that will literally not allow users to sell their tokens back to the decentralized exchange.
Users can buy them, but they cannot sell them. They’ll just write in a piece of code that will only allow the developer to sell. That way, the token price will only go up because nobody else can sell their token even if they want to.
Then, when the price is really high, the rug puller will sell all the tokens that they either gave themselves or that they bought very early on during the launch at a very low price.
Now that you know what a rug pull is and hopefully how it works, let’s continue and go over some ways that you can find out how to avoid one.
Sign of a Rug Pull,
Here are some signs that a rug pull might be evident.
- The liquidity is not locked.
Remember how I said that a developer could yank the liquidity out of a decentralized exchange? Well, sometimes, to prove that they are a legitimate project, many developers will lock up their liquidity with a trusted third party to ensure that they can’t pull out that liquidity even if they wanted to.
This is a perfect sign that the project will not get rug pulled, but you should know the option for the price to be manipulated is still there.
I recommend paying close attention to how long that liquidity gets locked up, though. Some projects will do it for two months, while others will do it for 500 years.
- A Few Wallets Have a Large Percentage
The second thing to look for is if a few wallets have a large percentage of all the coins on either scan or BSC scan, which are two large blockchain explorers.
You can actually go in and see who holds the largest majority of a token and if the top 10 wallets hold a huge amount of all the tokens created.
It is very likely that the developer bought a bunch at a cheap cost during the initial launch, and even if they didn’t, you should still watch out for those few large whale wallets. Why?
Because even if it isn’t the developer, a whale selling 2% of all the tokens at once can still considerably crash the price due to how automated market maker algorithms work.
It doesn’t have to be the developer doing the rug pulling. Any whale can manipulate the price of a token.
- The Burn Wallet has a Large Percentage.
The third thing you should watch out for is a little tricky. What they do is the burn wallet will have a huge percentage, which hides the true big wallets.
Another trick many developers who plan a rug pull will try is to create a ton of tokens, and then they will burn a large majority of them.
Even if you’re looking at one of those blockchain explorers I mentioned earlier, the list of wallets will show even the top holders holding a tiny percentage.
If you don’t already know, Burning means sending that token to an address that nobody controls—essentially getting rid of that token forever.
To understand this, imagine if we made 100 tokens. Let’s say we burned 90 of them. And so, there were only ten tokens left.
Well, if one person holds one token on the blockchain explorer, it’ll show that they have 1% of all tokens, which isn’t that much.
Even though, in reality, they hold 10% of all the circulating tokens, which is definitely considered a whale.
- No Audit
The fourth thing to look out for is an audit. Audits done by third parties are also good things to look out for. If a project has multiple audits performed by a few different trusted sources, you can use this in your investing strategy.
Projects with no audits are a blazing red flag.
- No Website or Social Media
The fifth thing to check out is their website and social media. So, another big red flag is that the project has no social media or even a functioning website because anyone wanting to make a quick buck can quickly create a token and upload some posts to Reddit to help get it some traction.
However, it takes a lot more time to create distinguished social media pages and to set up a website. You definitely need to be sure to check those out.
- No Multisig Wallet
Lastly, one thing to keep track of is if a developer’s wallet has a multi-signature wallet. This essentially means, if a whole team is working on a project, one person can’t go and steal the private key and withdraw all the funds.
For any transaction to happen on this developer wallet, this wallet requires multiple passwords from multiple people, which in turn decreases the potential of one person getting greedy and running away with the funds.
Now, the only true way you can figure this out is to check what the developers post on their website or Discord or Telegram group, and you must trust that they’re not lying.
Lastly, let’s go over who is responsible for a Rug pull, which is basically a scam or con and even literal fraud.
Is Anyone Held Responsible for a Rug Pull?
Given how new the world of decentralized finances and how limited the SEC and other financial institutions are with this new technology, the Defi world is currently hardly regulated.
This is why big names like Elon Musk or Mark Q cannot be held responsible for talking, making tweets, and even bumping a stock, just as the creators of a coin can’t be held accountable.
There just aren’t any laws against it yet.
Another big cloaking mechanism is that most crypto is anonymous, meaning there’s no name, address, or social security number tied to the creator of any of these new coins or tokens.
In short, we couldn’t sue them or go after them even if we were allowed to, and if it was illegal, how would we even regulate it?
Well, this is a question for another article.
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