What is a “rug pull”?
In the cryptocurrency industry, “rug pull” is a term mostly used to describe a scam project that is launched solely for the purposes of stealing investor cash. They claim to be new cryptocurrencies and are marketed in the same way, but after pumping the price of a token and receiving millions in investment cash, the creators take off with the money in the liquidity pool and leave the project to die.
However, not all rug pulls are built to be a scam from the beginning. To understand the difference between those that are and those that aren’t, we need to look at the two different types of rug pull, which are often described as “hard” and “soft” pulls.
Hard and soft rug pulls: What’s the difference?
Hard rug pulls occur when developers use hidden code to create a “backdoor” into a project’s smart contract, which can later be used to pull all its funds. This code is there from the very beginning of the contract’s launch, which indicates it was always the creators’ intention to walk away with the cash.
A soft pull occurs when a project’s creators dump their own tokens quickly, leaving a severely devalued project with no future in the hands of remaining investors. Although this may have been their intention from the beginning, it sometimes happens with legitimate projects that have simply run out of steam. Creators cannot see a way forward, so they take what they can and leave.
Rug pulls usually happen with ICOs and IDOs, since these are easier, much more affordable ways to launch a new cryptocurrency project. It’s less likely for IEOs, which require a significant amount of investment to begin with and much more stringent processes, to be exploited in the same way.
How you can avoid rug pulls?
Rug pulls are something every cryptocurrency investor should be mindful of. No one wants their hard-earned cash to just disappear without a trace. So, how exactly do you avoid them? It can be tricky if you like to invest in new cryptocurrency projects that could take off quickly, earning you a nice return on your investment. But there are some things you can look out for if you want to reduce your risk.
Locked liquidity
When a cryptocurrency project has a locked liquidity pool, its funds are secured through time-locked smart contracts, some of which could run for up to five years. In other words, the money in the pool (or at least large portions of it) cannot be withdrawn until those contracts expire. A project without locked liquidity does not have the same protection, making it much easier for creators to take off with the cash.
It should be noted that developers can create their own time-locked contracts that could be designed to be exploited at some point. But when third party locks are used, like those offered by a decentralized exchange, the project is likely to be a much safer investment.
External audits
Trusted cryptocurrency projects, even new ones, are now increasingly likely to have been audited by a reputable, independent company. Even decentralized exchanges make this a requirement now. Auditing is when the project’s code is examined to ensure there are no backdoors or other secret flaws that developers can take advantage of to steal liquidity later.
You shouldn’t trust a project that has not had an external audit. And when a project claims they have been audited, you should be able to verify this by seeing the report on the auditor’s website.
Limits on sell orders
Some cryptocurrency projects will impose limits on sell orders, making it more difficult for investors to sell their tokens. Usually, those limits are only in place to lock investment cash so that project creators can take more for themselves in the future.
Sadly, it’s difficult to identify whether limits on sell orders are in place. One of the simplest ways to find out is to make a small investment in the token, then immediately attempt to sell it. If you are unable to sell, it’s likely because the developers designed it that way, and the project is likely a scam.
Anonymous creators
One of the great things about the cryptocurrency industry is the ability to trade somewhat anonymously. Unfortunately, it’s relatively easy for project creators to remain anonymous, too — and when they do, it’s often because they do not plan on sticking around and do not want to be traced.
Not all anonymous projects turn out to be scams. Just look at Bitcoin, the most valuable cryptocurrency in the world, whose developer “Satoshi Nakamoto” remains anonymous to this day. But things are different in the modern cryptocurrency industry, and an anonymous team is usually one to avoid.
Strange price movements
If you look at the value of a new cryptocurrency project and something just doesn’t add up, that could be a sign that it’s not genuine. Big fluctuations in token price, particularly when the value of a new coin rises rapidly, should be viewed with skepticism. This is often a sign that developers are pumping up the price of the token before they dump their share and move on.
Use your best judgement
Now you know some of the biggest things to look out for to avoid rug pulls and scam projects. It’s important to bear in mind, however, there is always a risk involved with trading, even outside of the cryptocurrency industry, and it’s impossible to guarantee a return on your investment. Even the most genuine projects (and the biggest companies) have imploded and died out in the past.
The best thing you can do when cryptocurrency trading, then, is use your best judgement. Research projects you’re interested in, and only invest in those that you can trust. Stick to trading with centralized exchanges if you have to. And always be aware that while some investments will be winners that earn you money later, others will inevitably be losers.
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