What Is Rug Pulling In Crypto?

In crypto, rug pulling is one of the most common deceptive practices where developers withdraw all funds from a project abruptly.

This act leaves investors with worthless tokens and, as a result, undermines trust in that project as well as crypto in general. In this article, we will discuss what constitutes a rug pull and how you can identify one and avoid such scams to ensure that your investment is safe.

Key takeaways

• Rug pulling is a type of scam that leaves investors with worthless tokens. This typically involves the developers promoting a new token, boosting its value, and then pulling out all the liquidity.
• Developers often launch these scams on decentralized exchange (DEXs) where less rigorous KYC and AML checks allow for anonymity.
• Potential rug pulls often show certain red flags, such as rapid price increases driven by aggressive social media promotion.
• Besides classic liquidity pulls, rug pulls can occur through mechanisms like limiting sell orders, where developers prevent others from selling their tokens while they cash out.

Definition of rug pulling

In the cryptocurrency world, a ‘rug pull’ refers to an exit scam where developers abandon a project and run with investor funds. This term comes from the expression ‘pulling the rug out’, which denotes unexpectedly withdrawing support.

Developers typically create a new token, pair it with a reputable cryptocurrency like Ethereum (ETH) or Solana (SOL), and list it on a DEX without any necessary audits. They then promote the project to attract investment. Once sufficient funds are raised, the developers withdraw all liquidity from the pool, leaving investors with worthless tokens.

This scam is quite often carried out through DEXs, which do not require the rigorous KYC and anti-money laundering (AML) checks found on centralized exchanges. As a result, DeFi projects can launch and operate with anonymity, making it easier for individuals to execute a rug pull without risking their identity.

Typical signs of a potential rug pull include a sudden increase in token prices driven by widespread promotion on social media platforms. These developers either pay crypto analysts with a decent following to shill the token or pay a celebrity to put out a tweet.

Either way, the promotion is likely to attract investors who will invest in the coin expecting life-changing returns. Instead, the developer pulls the liquidity, and the investors are forced to sell the coins at a loss. Rug pulling is also prevalent in the NFT sector, where the price of a digital art is inflated artificially through false claims. This is usually done to sell the cheap pieces at a higher rate.

Common characteristics of rug pulls

As there is an evident rise in the number of rug pulls, investors should look out for some red flags that are common for these projects. Even though the technique used by the projects could be different, investors should watch out for these similar traits:

1. Anonymous or unverified teams: Projects with legit team members usually have their social media channels linked on the project’s website. In other cases, there will be images of team members on X or LinkedIn. Projects led by anonymous developers or those without verifiable credentials lack all these. These project developers choose to stay behind the curtain so that they vanish without a trace, often taking investors’ funds with them.
2. Unrealistic returns: If a project or its team members promise unrealistically high or guaranteed returns, it should raise immediate red flags. All investments carry inherent risks, and such claims of high profits are often signs of rug pulls or scams.
3. Lack of transparency: Credible projects typically provide detailed information about their technology, goals, and progress. A project that lacks clear information, including a roadmap and whitepaper, should be approached with caution.
4. No external audits: Trustworthy crypto projects usually undergo audits by reputable third-party security firms to validate the integrity of their code. The absence of an audit report could be a sign of potential vulnerabilities or intent to defraud.
5. Concentrated token ownership: If a small number of holders control a large fraction of the total token supply, they can manipulate the market by suddenly selling off their tokens. In such situations, they can dump the tokens and crash the value, leaving other investors with losses.
6. Locked or restricted selling: Some projects may restrict investors from selling their tokens for a certain period. Interestingly, these developers or early investors are free to sell their holdings. Many times, this could result in losses for other investors.
7. Sudden removal of liquidity: Rug pulls often involve developers withdrawing all liquidity from DEXs. This puts the investors in a situation where they are unable to sell their tokens.
8. Aggressive marketing: If a project is doing rigorous marketing by promoting them via press releases, sponsored articles, and influencer tweets, it could be taken as an indication that they plan to attract more investors rather than provide more value.

While these are the most important characters to look out for, there are also a few additional signs:

• Poor communication channels: If the project’s team members are nonresponsive on social media, including X and Telegram, it can be a warning sign. Legit projects usually communicate with their community for feedback and development.
• Unusual tokenomics: Complex or unclear token distribution models that allocate an excessive portion to developers or have confusing vesting schedules can also indicate a scam.

Types of rug pulls in crypto

Once you have the necessary details on how a rug pull project looks, let us understand the different types of rug pulls that are prevalent now:

• Liquidity pulls: This type of rug pull occurs on DEXs. Developers launch a new token, and they promote the project to attract investments into the liquidity pool. Once they hit their investment goal, the developers withdraw all the liquidity and drop the value of the associated token.
• Dumping (pump-and-dump schemes): In these schemes, developers or insiders initially hold a large portion of the token’s supply. They then drive up the token’s price using misleading information or excessive hype. When the price is high enough, these insiders sell their holdings.
• Limiting sell orders: Some rug pulls involve smart contracts coded to prevent investors from selling their tokens while allowing purchases. This restriction creates an artificial demand and apparent price stability. Developers exploit this setup by selling their tokens at these high prices. Once they remove the selling restrictions, the token’s value plummets.
• Fake projects: These scams involve the creation of seemingly legitimate projects that are marketed to lure investor funds. However, once the developers collect enough money, they disappear and abandon the project.
• Soft rug pulls: Soft rug pulls occur when the project’s development team gradually reduces their involvement and support, creating a false sense of security among investors. This method is unethical as it misleads investors about the project’s viability and future. In the longer run, it results in a slow decline in the token’s value without a sudden withdrawal of funds.

Historical examples of rug pulls

• OneCoin (2014–2016): Founded by Ruja Ignatova, OneCoin was marketed as a revolutionary cryptocurrency. However, it turned out to be a Ponzi scheme and defrauded investors of over $4billion. Ignatova disappeared in 2017 and remains at large.
• Thodex Exchange (2021): Thodex was a Turkish cryptocurrency exchange that abruptly halted trading and withdrawals in April 2021. Its CEO, Faruk Fatih Özer, fled the country. He allegedly took $2bn of investors’ funds.
• Squid Game Token (2021): Capitalizing on the popularity of the Netflix series ‘Squid Game’, developers launched a token that saw its price soar to over $2,800. Shortly after, the developers executed a rug pull, draining liquidity and causing the token’s value to plummet to near zero.
• AnubisDAO (2021): AnubisDAO was a decentralized autonomous organization that raised nearly $60m within hours of its launch. However, the project’s liquidity quickly disappeared as the developers absconded with the investors’ money and left participants with worthless tokens.
• Luna Yield (2021): Luna Yield was a yield farming project on the SOL blockchain. Shortly after its launch, the developers withdrew all funds from the liquidity pools, disappearing with approximately $6.7m of investors’ money.
• Frosties NFT (2022): Frosties was an NFT project that sold out its collection, raising about $1.3m. Soon after, the developers shut down the project’s website and social media, disappearing with the funds. This incident led to the arrest of the project’s creators, marking one of the first enforcement actions against NFT rug pulls.
• Big Daddy Ape Club (2022): This project promised 2,222 ape-themed NFTs on the SOL blockchain, aimed to be listed on the Solanart marketplace. Via the rug pull, the developers raised about $1.3m. Unlike typical rug pulls that deliver some form of NFT before disappearing, the Big Daddy Ape Club collected funds for minting but never actually created any NFTs. Before the minting date, the developers locked and then deleted the project’s Discord server, with the website and X account vanishing soon after.
• Baller Ape Club (2022): Similar to Big Daddy Ape Club, Baller Ape Club revolved around another ape-themed NFT collection. Its founder, Anh Tuan, is accused of fleeing with $2.6m from investors. Following the project launch and rapid collection of funds, the project’s website was deleted, and the money was laundered.

Most recent rug pull by a 13-year old

A 13-year-old meme coin creator’s live-streamed rug pull on a Solana-based token, Gen Z Quant, has sparked debate about the risks of meme-based cryptocurrencies. The young developer managed to make $30,000 by selling his stake during the stream, significantly dropping the token’s price. This incident occurred on the pump.fun.

Following the rug pull, the crypto community reacted by injecting more funds into the token. This temporarily increased its market cap to $85m. If the teenager had retained his stake, it could have been worth $4m.

Subsequently, the creator launched two additional tokens named ‘I’m Sorry (SORRY)’ and ‘LUCY’. Each time, he sold his holdings at a peak, first earning $400,000 from SORRY and then $20,000 from LUCY at different market caps.

These incidents have led to discussions about the ethics and risks of such investments. In a Reddit thread on r/explainlikeimfive, users debated how individuals, including influencers, can manipulate coin values and exploit followers.

A user named Connor explained the process, highlighting how influencers can exploit their audience by hyping up worthless coins and then selling their holdings at a peak, leaving followers with losses.

Consequences for victims of rug pulls

Victims of cryptocurrency rug pulls face several consequences that go beyond financial losses. This could impact their emotional well-being and trust in the crypto market.

Financial loss: The most direct impact of a rug pull is the financial loss experienced by investors. Typically, victims may lose their entire investment overnight. This was what happened during the Squid Game token scam in 2021, where the token’s value crashed to zero.

Emotional and psychological impact: The aftermath of a rug pull often leaves victims with intense emotional distress. They will also go through feelings of betrayal and embarrassment. This psychological toll can lead to a distrust of similar investment opportunities.

Legal and recovery challenges: Attempting to recover lost funds from a rug pull proves to be a daunting challenge. The anonymous and decentralized nature of blockchain technology complicates efforts to trace and recover investments. Although victims can report these frauds to regulatory bodies or join class-action lawsuits, the chances of recovering any funds are usually minimal.

Reputational damage: For influencers or financial professionals who endorsed a fraudulent project, there is a risk of reputational damage. Their professional credibility may suffer, impacting their career and future opportunities in the financial community.

Market implications: On a larger scale, frequent rug pulls undermine public confidence in the cryptocurrency markets. This loss of trust can push away new and existing investors, stifling the growth and innovation within the broader blockchain and cryptocurrency sectors. The fear generated by these scams makes it harder for real projects to attract investment.

Legal implications and regulations of rug pulls

Fraud charges: Individuals who planned and executed rug pulls may face fraud charges. Depending on the scale of the scam, the individuals may receive varied charges.

Money laundering allegations: Rug pull schemes generally involve several methods to obscure the trail of stolen funds, such as chain-hopping, which is moving assets across multiple cryptocurrencies to hide their origin. This can lead to money laundering charges, as was the case with the founder of Baller Ape Club. Le Anh Tuan faced charges for wire fraud and international money laundering after misappropriating investor funds.

Regulatory actions: To prevent the prevalence of crypto scams, regulatory agencies worldwide are tightening scrutiny on cryptocurrency projects. Nations are crafting regulations aimed at better protecting digital asset investors from fraudulent activities.

The SEC also released a press release highlighting how the commission obtained orders for $8.2bn in financial remedies. The agency highlighted several fraud cases, with one of the benign NovaTech, which raised more than $650m in crypto from 200,000 investors.

Challenges in enforcement: Despite regulatory efforts, the decentralized and anonymous characteristics of blockchain technology pose major obstacles in tracking and prosecuting offenders. Law enforcement agencies often require international cooperation to effectively address these challenges.

Investor recourse: For victims of rug pulls, legal recourse options are limited and often ineffective. While civil lawsuits can be pursued, the anonymous nature of blockchain can make it difficult to identify and prosecute the culprits. Recovery of stolen funds is typically rare, reflecting the need for investors to exercise caution and perform due diligence.

Preventing rug pull scams

To protect yourself from falling victim to rug pull scams in the cryptocurrency space, it is necessary to implement several preventive measures.

Conduct thorough research:

• Verify developer identities: Always check that the project’s team members have transparent and verifiable backgrounds. Projects led by anonymous or pseudonymous developers often carry higher risks.
• Assess project documentation: Carefully review the project’s whitepaper, roadmap, and technical details. This can help you understand its feasibility and assess its legitimacy.

Evaluate community engagement:

• Active communication: Legitimate projects typically maintain active communication with their community through platforms like Discord, Telegram, or X. Engaging with these communities can provide insights into the project’s credibility.
• Transparency: Look for developers who provide regular updates and respond openly to community inquiries and concerns.

Analyze tokenomics:

• Distribution: Be wary if a small number of people hold a large percentage of the token supply, as this could lead to potential market manipulation.
• Liquidity locks: Confirm whether the project’s liquidity is secured in a smart contract for a set period, which minimizes the risk of developers withdrawing liquidity suddenly.

Seek external audits:

• Security audits: Ensure the project’s smart contracts have been audited by reputable third-party security firms to uncover any vulnerabilities.

Be wary of unrealistic promises:

• High returns: Approach projects promising guaranteed or exceptionally high returns with caution, as these claims are typical indicators of scams.

Test the platform:

• Functionality: If possible, make a small initial investment to test the platform’s functionality, ensuring that the buying and selling processes work as promised.

Stay informed:

• Continuous learning: Keep up-to-date with the latest trends and developments in the cryptocurrency industry. Educate yourself about common scam tactics and learn from previous incidents to better recognize potential frauds.

Community awareness and resources

Building community awareness is important for preventing rug pull scams in the cryptocurrency space. By using educational resources, investors can make better decisions.

Educational platforms:

• Coinbase Learn: Provides extensive guides that help users identify and avoid rug pulls.
• CoinGecko Learn: Offers insights into recognizing scam tokens and understanding the current market trends.

Community forums and social media:

• Reddit: Participate in subreddits like r/CryptoCurrency and r/DeFi, which are valuable for discussions and alerts on potential scams.
• X: Following reputable crypto analysts and organizations can keep you updated with real-time information on suspicious projects.

Blockchain explorers:

• Etherscan: Use this tool to scrutinize token contracts and monitor transaction histories, helping identify any irregular activities.
• BscScan: Functions similarly to Etherscan but focuses on the Binance Smart Chain, assisting in the analysis of token movements and potential red flags.

Audit services:

• CertiK: Known for providing thorough security audits for blockchain projects, CertiK helps investors verify the security and credibility of potential investments.
• QuillAudits: Specializes in smart contract audits, identifying vulnerabilities and potential security risks in the contract code.

Regulatory bodies:

• SEC: The SEC offers alerts and guidelines about fraudulent cryptocurrency schemes, which are crucial for staying informed about the legal aspects of crypto investments.
• Financial Conduct Authority (FCA): Provides resources and warnings regarding the risks associated with crypto assets and projects, helping investors make informed decisions.

1. 01.

   Is rug pulling in crypto illegal?

   

   Yes, rug pulling in the cryptocurrency space is illegal. It involves developers abandoning a project after securing investments and ends up defrauding investors. Such actions are considered fraudulent and can lead to legal consequences, including charges of fraud and money laundering.

2. 02.

   How to tell if a crypto is a rug pull?

   

   Identifying potential rug pulls requires thorough research. Be cautious of projects that exhibit the following characteristics:

   • Anonymous or unverified teams: Projects led by anonymous developers or teams without verifiable backgrounds pose significant risks.
   • Unrealistic returns: Promises of exceptionally high or guaranteed returns are red flags.
   • Lack of transparency: Projects that do not provide clear information about their technology, goals, or development progress should be approached with caution.
   • No external audits: Reputable projects typically undergo third-party security audits to ensure the integrity of their code.
   • Concentrated token ownership: If a small group holds a large percentage of the token supply, they can manipulate the market by selling off their holdings.
3. 03.

   What does rug pull mean in crypto?

   

   In the cryptocurrency context, a ‘rug pull’ refers to a fraudulent scheme where developers create a new token or project, attract investors, and then abruptly withdraw all funds, leaving investors to lose a majority of their investment.