Even if you’re not a regular Netflix viewer, you will undoubtedly have heard of Squid Game. The viral TV series attracted record-high views in a few weeks when it was first released in September 2021.
Unfortunately, the massive hype gave way to a short-lived scam that capitalized on the popularity of the drama series, despite having no real association with it. A crypto scam project dubbed the SQUID coin purported itself as a way to play games inspired by the show.
From its opening trading day on 26 October 2021, the token’s price had reached a staggering $2862 by the start of November but eventually crashed in a matter of minutes.
The bad actors behind the scheme reportedly pocketed about $3.4 million. This event was a classic case referred to in DeFi (decentralized finance) as a ‘rug pull.’
While the DeFi industry has been booming over the last few years, it hasn’t been without controversy. This has left investors having to think twice when observing any potential investment.
This article explains the rug pull concept in more detail and how not to have anyone pull the rug out from under you.
So, what is a rug pull?
A rug pull (also called an exit scam) is a loose equivalent of a pump-and-dump scheme prevalent in DeFi.
More specifically, it is a malicious act where a development team behind a recently-listed token unexpectedly abandons the project and runs away with investors’ funds.
Due to advancements in blockchain technology, it has become much easier nowadays for the average Joe to create their own cryptocurrency and have millions of investor funds poured into it.
The modus operandi involves listing a token on a decentralized exchange (DEX) as these platforms perform little or no identity verification checks compared to centralized exchanges.
Moreover, many projects in crypto are known for having anonymous developers, further making the process even simpler. The criminals set up a liquidity pool on a DEX by pairing the new token with another cryptocurrency like ETH (Ethereum) or BNB (Binance Coin).
Funds are generally locked in that liquidity pool for a prescribed period. Similar to a pump-and-dump scheme, the malicious developers promote the token with overblown value propositions, attracting even more investors.
Of course, this increases the value of the fake coin. At some point in time, the developers will eventually withdraw all the ETH or BNB from the pool, making the token worthless as it tanks in price. Moreover, investors will not be able to trade this crypto back to the ETH or BNB.
Tell-tale signs of a potential rug pull
Fortunately, with a bit of due diligence, rug pulls tend to exhibit one or a few of the warnings below.
Anonymous developers
Of course, many legit crypto projects exist with anonymous developers (e.g., Bitcoin). However, this is more suspicious for a new token, meaning the risk in investing isn’t worth taking.
A bonafide project should have a team of well-known developers with a verifiable and clean history.
The project appeared overnight
Virtually all rug pulls are the result of low-effort, massively hyped projects. In other cases, they may simply be copycats of an existing cryptocurrency. An actual, investable project usually takes years to develop and will have a trail to verify how long it’s existed conceptually.
Therefore, one reliable method to identify a potential rug pull is seeing when the project was conceived. If it seems like a recent idea, it’s probably too good to be true. Another sign to observe is the whitepaper length.
Compared to the tens of pages for established cryptocurrencies, a new cryptocurrency will have a paper only a few pages long.
Similarly, you should also check social media presence. Scam cryptos will understandably have far fewer followers with barely any engagement. In some cases, the website will look basic and have words like ‘launching soon’ or ‘work in progress.’
Ultimately, credibility in any cryptocurrency boils down to time.
Low liquidity
Thanks to most blockchains being publicly distributed, you can verify the liquidity of any cryptocurrency. Liquidity simply refers to the ability to convert the token into another currency (whether fiat or crypto) without causing an adverse reaction to its price.
This metric is also used to measure how valuable a cryptocurrency is. If a coin has lower liquidity, this can cause the value to depreciate at any given time drastically.
Established cryptocurrencies will have a 24-hour trading volume in the tens of millions of dollars, while it could be in the tens of thousands for less developed tokens.
A general rule of thumb is the volume over the last day should be at least 10-40% of the coin’s market cap (price multiplied by the total number of coins).
Disproportionate token ownership
A blockchain explorer like Etherscan can show you the token ownership and supply according to individual wallet addresses. Generally, if you find a single wallet holds over 10% of the entire distribution, price manipulation can happen more easily, meaning you should be suspicious.
Lack of audits
Another solid verification method is seeing whether the project has been audited for security and financial transparency. Although no law states a cryptocurrency must follow this procedure, it certainly lends credence and drastically decreases the chances of something fishy.
Resources to use in avoiding rug pulls
The most popular blockchain explorer is Etherscan, as most tokens are built using the Ethereum blockchain. Another prevalent resource in this regard is BscScan for coins of the Binance Smart Chain standard.
With these tools, you can view useful information like total supply, number of wallets, etc. Other means for identifying potential rug pulls include Token Sniffer. The site lists all the latest scams and computes smart contract data to look for vulnerabilities.
A resource with similar functions is Rug Doctor, which, like Token Sniffer, looks for red flags in newly-listed tokens.
Final word
While DeFi has provided users with unimaginable freedom in moving and making money, the trade-off has been poorly enforced regulations leading to all types of scams, one of them being rug pulls.
As they say, always DYOR (do your own research) in this industry. Hopefully, this article has armed you with beneficial information to avoid being a victim of the dreaded exit scam.
