Cryptocurrencies: the worrisome phenomenon of rug-pulling (and how to protect yourself)

November 28, 2023

The term rug-pull, literally "pulling the rug out," may evoke comical cartoon images, but in the world of cryptocurrencies, it has become a worrisome phenomenon for investors.

This practice, which (while not new) has become alarmingly common in the era of decentralized finance (DeFi), is a scam in which developers of a cryptocurrency project lure investors with promises of innovation and high returns, only to suddenly disappear with the accumulated funds.

This phenomenon has not only caused significant financial losses, but also generated distrust in the cryptocurrency ecosystem.

Let's see what rug-pulls are, how they work, and how investors can protect themselves from them.

First of all, what is a rug-pull?

Rug-pull definition

When it comes to cryptocurrencies, a rug-pull is a common type of scam where developers of a Web3 project advertise an attractive project to outside investors, only to then run away with the money and completely abandon the project.

This type of scam is not unique to the crypto space but has become a popular target for scammers due to the vulnerabilities they have learned to exploit, such as lack of consumer education and the irreversible nature of cryptocurrency transactions. While these types of

scams have always existed, in this particular case, without legal or regulatory oversight, rug-pulls leave scammed investors with few options to trace or recover stolen funds.

OneCoin: The most popular rug-pulling scam

Perhaps the most famous cryptocurrency pyramid scam was OneCoin, which defrauded $4 billion on the promise of being the new and improved BitCoin. Ironically, the coin was not actively traded, and was not even based on blockchain, but on a simple SQL server.

OneCoin founder Ruja Ignatova disappeared in October 2017 without a trace and is still wanted by US authorities for fraud and conspiracy. Currently, she remains the only woman on the FBI's Ten Most Wanted list. If convicted, she faces up to two decades in prison.

After Ignatova disappeared, her brother, Konstantin Ignatov, took over, but was arrested in 2019 and eventually pleaded guilty to fraud and money laundering.

How does the scam work?

A rug-pull typically begins with the creation of a new cryptocurrency token, which is listed on a decentralized exchange and paired with a coin from a leading platform such as Ethereum.

Scammers then harness the power of social media marketing, launching a promotional campaign full of excitement and expectation to attract a community of investors. These scams often dangle empty promises of incredibly high returns or accumulate users in Ponzi-like schemes (pyramid scheme).

With enough traction, the reach of the platform increases along with the value of your token. Once the price peaks, the development team unloads its stake in the tokens, taking the balance of investors' funds. Sometimes, this has been planned from the start of the project, and sometimes, developers become convinced at a later stage that a project will fail.

Rug-pull types

Rug-pulls can come in two main varieties: hard and soft.

A hard rug-pull occurs suddenly, with no warning signs. The numbers plummet to zero and all tokens immediately lose their value, leaving investors aware that they have been defrauded and the creators have abandoned the project.
On the other hand, in a soft rug-pull, developers play for the long term, it involves a more prolonged approach, where developers sell a false public image of dedication to the success of the project along with the gradual sale of their coins.

There are several common tactics used in rug-pulls within these categories, including: stealing liquidity, limiting sell orders, and dumping or dumping tokens. Each of these tactics has its own particularities and methods of execution, but they all share the common goal of defrauding investors.

What can we do to avoid falling victim to a rug-pull?

It is essential to take precautionary measures and conduct thorough research before investing to avoid becoming a victim of a rug-pull in the world of cryptocurrencies. The following are 10 strategies to protect yourself:

Project research: Before investing, investigate the project. Look for information about the team behind the project, their history, and their reputation in the community. If the developers are anonymous or have a questionable track record, it's a red flag.
Source code review: If you are tech savvy, review the project's source code if it is available. Open, third-party audited code is a good sign of transparency and security.
Read the whitepaper: The project's whitepaper should clearly explain the objectives, strategy, technology used and economic model. Be wary of projects that do not have a clear whitepaper or that make unrealistic promises.
Community and social networks: Analyze activity on social networks and forums. An active and positive community can be a good indicator but beware of fake accounts or overly promotional comments.
Liquidity and trading volume: Projects with low liquidity or trading volume may be more susceptible to rug-pulls. High liquidity indicates a genuine and sustained interest in the project.
Investment diversification: Don't put all your eggs in one basket. Diversification helps mitigate risks.
Staying updated: Stay informed about market trends and news. Cryptocurrency forums and news platforms are good sources to stay up to date.
Avoid FOMO (Fear Of Missing Out): Don't get carried away with excitement or fear of missing an opportunity. Take your time to research before investing.
Use well-known platforms: Invest through more recognized exchange platforms, which offer a certain level of security and credibility.
Seek advice from experts: If you have doubts, consider seeking advice from people familiar with this type of new investments before taking the plunge.

You can significantly reduce the risk of falling for a rug-pull and protect your investments in the volatile world of cryptocurrencies by following these guidelines.

Conclusions

Rug-pulls can be surprisingly common, as evidenced by the fact that in 2021 alone, fraudsters managed to defraud nearly $2.8 billion through these tactics according to a report by specialist company Chainalysis.

In this month of November, it was confirmed that a token named GOW39 and launched on the BNB Chain platform was indeed a rug-pull. More than $200,000 was mined and subsequently the price of the token went to zero.

All in all, this situation underscores the importance of understanding the risks associated with investing in cryptocurrencies and the need for constant vigilance in this emerging market.