Some scams are easy to see, but others might look like a worthwhile investment opportunity. Here are some crypto red flags to look out for.
Cryptocurrency investors have recently fallen prey to scams which see founders pull the plug on the project out of nowhere, leaving investors high and dry. The scam type, known as a rug pull, takes on a few different forms. Knowing what it looks like might help you avoid losing your funds to a fraudulent project.
What is a cryptocurrency rug pull?
A “rug pull” in cryptocurrency is a type of scam that happens when a person creates a fraudulent project which might come across as legitimate, hypes up the token and the function, pumps up the price to attract investors, and then disappears with the funds. It’s called a rug pull because it feels like investors have had the rug pulled out from under them, believing a project is a worthwhile investment only to realise it’s a scam and they are left with a valueless asset. It occurs in decentralised finance (DeFi) where the legalities for investment are a lot less regulated than traditional finance.
The three different types of rug pulls
There are three different types of rug pulls one might see in cryptocurrency. These are:
- Liquidity theft,
- Limiting sell orders, and
- Pumping and dumping.
Liquidity theft, or liquidity stealing, happens when the founder of a project (the creators of a token) suddenly withdraw all the coins from the liquidity pool that’s being used to fund a project. When this happens, the value that’s locked into the token is removed, leaving investors with a worthless asset that can’t be used for anything. This type of rug pull is most common in the DeFi space.
Limiting sell orders
This is a more subtle way to fraudulent founders to steal from investors. In this type of scam, a developer codes a token with a smart contract that means they are the only party that can sell them. This means that the token itself can’t be sold by investors to other peers, locking them into an asset that can’t be traded. When enough investors have bought the token and the founder is sitting on a profit, they dump their tokens, leaving investors with valueless tokens they can’t do anything with.
Pumping and dumping
When a founder or crypto developer quickly sells off a significant portion of their own tokens, it’s referred to as dumping them. When this happens, the price of the coin is radically driven down as the demand essentially decreases and the available supply shoots up. In a rug pull, fraudulent founders will pump the token, to increase the value and attractiveness of the cryptocurrency to hype investors to the project. With marketing and promotion, vulnerable investors will buy the tokens. When the price action is high, the founder will dump the tokens, taking profit from the hype.
The two different forms of rug pulls
There are also two different forms that a rug pull can come in:
- Hard rug pulls, and
- Soft rug pulls.
A hard rug pull in cryptocurrency
A hard rug pull happens when a founder uses coding to maliciously use the project as a way to defraud investors. This means there are hidden things in the smart contract that are designed to dupe investors and the intent to steal funds is evident in the code. Liquidity stealing is an example of a hard rug pull, because the code is written in such a way to lock investors into an asset which has no genuine direction or function.
A soft rug pull
Soft rug pulls in cryptocurrency scams are when founders and teams dump their assets rapidly, devaluing the token and exploiting the profit that is created from investors buying the cryptocurrency. The intent to steal from investors might be there from the start, but the project’s token is not designed by code to defraud investors.