What is a Rug Pull in Crypto and NFTs?

You are taking your daily cup of coffee as you browse the internet when you notice some newly minted NFTs and cryptos going viral. You wonder what the whole commotion is all about.

You research and see that profit returns are through the roof with the new project you found. Everyone seems excited about it as it accumulates positive attention and promotion from its community. And worried that you would miss out on this alluring opportunity, you take the risk and put some of your funds into the project.

You monitor your funds for the next couple of hours and feel delighted as you watch your portfolio massively grow. The next day you check your portfolio, only to find that its market cap has dropped to zero, making your investment worthless.

Now you feel devastated and swear to never invest in NFTs and cryptos again. And this is how you became a victim of an infamous rug pull.

It’s such a tragedy, but instead of fearing it, why not learn more about it and understand how it works to avoid it happening in the future? Agree? If so, then let’s dive right in.

What exactly is a Rug Pull?

In simple terms, a rug pull is a mischievous operation where the developers ditch their crypto or NFT project and run away with all the funds and investments made by their community.

Everyone is always on the lookout for the newest and hottest thing that would bring quick profits to their table. And since everything spreads like wildfire on the internet today, it is always a challenge to determine which project is worth your time and investment.

Rug pulls are so rampant that they successfully took over $2.8 billion in 2021. It is a wake-up call that everyone should be aware of as one of the dangers of unknowingly entering the world of investment on the blockchain.

Not everything online can be trusted, and even an entire community can fall victim to such schemes. So it is never a good idea to jump on the bandwagon and go with the hype without doubting the project or doing some thorough research yourself.

How does a Rug Pull happen?

There are three different ways developers/founders execute a rug pull. They can either limit or remove your ability to sell, steal the liquidity, or pump the price before dumping it. You and the rest of the unlucky investors will be left behind as the developers you entrusted your funds to disappear without a trace.

Limiting or removing the ability to sell

The NFT or crypto project developers can make it so that they allow investors to buy in but prohibit them from selling or cashing out, or intentionally make it difficult to do so, inevitably causing the NFTs or crypto’s price to rise.

At first glance, this would appear positive as the market cap increases exponentially, enticing others to buy in as well, not knowing that the rug is about to be pulled from under their feet.

And, of course, the inability to sell does not apply to the project developers, so they can then sell the entirety of their shares and vanish into thin air.

Stealing from the liquidity pool

If you did not know, a liquidity pool refers to the crypto pool or tokens that are locked and managed by smart contracts. When you purchase new cryptos using ETH or other popular tokens, you give them your valuable funds in exchange for their worthless tokens.

Those funds will then get locked into the liquidity pool to which the developers have access. The devs can then withdraw all the funds from the liquidity pool, causing the price of the tokens you have purchased to drop to zero.

Pumping and dumping

The pump-and-dump scheme refers to the founders/developers exaggerating and over-embellishing their new NFT or crypto project. They would do everything to catch attention, like doing heavy advertisements, paying social media influencers to promote their project, or injecting their funds into the liquidity to manipulate its price.

It would trigger FOMO or fear of missing out, causing other investors to hop in on the craze. And when the developers have reached their target market cap, they will then sell or dump all the shares they hold and abandon their project.

How to spot and avoid a Rug Pull?

Spotting a rug pull can be tricky, especially when the developers try their best to make their project seem legitimate while trying to sneak behind the scenes without raising suspicion. But knowing the obvious indications will help you avoid such schemes. And below are the six (6) red flags that you should look out for:

1. No external third-party audits

A legit project must have an external audit from a trusted third party. It is now a standard for all DeFi projects, and one must not trust the developer’s words that they “have been audited.” The audit should be shown and verified by a third party. It is to ensure that nothing malicious is in their program.

2. Unknown developers

You, as the investor, have the right to be suspicious of everyone behind the creation and the promotion of the NFT or crypto project. And checking their track record is also a must before you risk investing.

Available information about them should answer questions like: Who are they? Where are they coming from? What were their past achievements? Were they part of some illegal activities in the past? And so on.

If the developers are unknown or do not have a reputable background, you should take that as a warning and proceed with utmost caution.

3. (Not) Locked Liquidity Pool

Earlier, we discussed that stealing the liquidity fund is one of the three ways a developer can pull the rug. Trusted and the most popular tokens lock their liquidity through the SmartChain as proof that they are legitimate and there is no way to steal those funds.

You should also know how long the liquidity pool stays locked and what percentage is locked. Between 85% to 100%, a good portion of the funds should be closed to ensure that none of the founders would go rogue and run away with all the money.

4. Abnormal price movement

Upon seeing that the market cap of an NFT or crypto project is skyrocketing, Investors would put in more money which will cause a ripple effect, driving the price even higher and attracting more investors. Only to find later that the project crashed and that they were involved in a rug pull.

If you see the price of the NFT or crypto spiking up abnormally high, it could be a tell-tale sign that things are about to go down. So be alert and get yourself to safety.

5. Suspiciously high returns

A project that promises to bring high yields does not necessarily mean that it is a scam. Although it still carries just as much risk to your investments, thus you should still think twice. And you also can not rule out the possibility of a rug pull happening, it could also be a Ponzi scheme, and you will never know until it hits you, so you should also be mindful about it.

6. Inability to sell

This one should be obvious as a blazing red flag. Before going all-in with your investment, doing a bit of digging would prevent you from making decisions that you might regret.

Seeing through this is tricky, but you can go through the feedback and comments from its community to see if there is an anomaly. Just make sure that the community is composed of real people and not some paid bots and dummy accounts meant to promote their product.

Having these signs would be an indication that they are not trustworthy. So if a project you are eyeing ticks the box of one or more of these signs, you should stay as far away from it as possible. After all, it is better to be safe than sorry, and protecting your funds should be your top priority.

Overview

Since the blockchain space exploded, it has provided countless opportunities and made millionaires in such a short period. Because of this, many projects have popped up, and instead of competing with the market, they would rather take advantage of all the hype by doing all means possible to deceive people.

So it is up to us as investors to be wary of them. And understanding how they operate and what to look out for surely helps us avoid and hopefully discourage them from doing such unethical measures.

A good NFT or crypto project has a solid foundation with a clear purpose and a long-term goal. Moreover, their reputation and true intent should reflect on their platform and with stable followers that fact checks everything and openly criticizes what needs to be improved or if anything suspicious happens.

Just know that the NFT and crypto market remains as volatile as ever, so you could still lose profit. It will not matter if the developers do not have any ill intentions. If another project outshines theirs, it will eventually fall behind and crash as people would realize the discrepancy. So it is still not a foolproof strategy to succeed; this is simply a guide about what a rug pull is and how to avoid it.

Disclaimer

And with that said, this article is for educational and entertainment purposes only. We don’t provide financial advice, and we discourage you from making any financial move without thorough research and guidance from a qualified professional. So invest at your own risk with due diligence before putting your money out there.