There is currently nearly $500 billion locked up in DeFi. As expected, easy money not only attracts investors/speculators, but also malicious people.
There are many dangers that are inherent in decentralized ecosystems, but most can be prevented with a bit of tech culture, especially when it comes to scams.
This article will answer the question “What is a rug pull?”, emphasizing one of the most popular scam methods in the crypto ecosystem.
What is a Rug Pull?
A Rug Pull takes place when developers abandon a project and run away with the funds, leaving investors with a sad bag full of worthless tokens.
Although they can occur in any crypto environment, they tend to occur more frequently in DeFi (decentralized finance) projects, since decentralized exchanges (DEX) such as Uniswap or SushiSwap allow any developer, malicious or not, to list their tokens without any type of audit.
How does a rug pull work?
This malicious technique takes advantage of the anonymous nature of decentralized blockchain-based ecosystems and their lack of regulation. It also exploits people’s technical ignorance and blind greed that FOMO (Fear Of Missing Out) brings.
The rug pulls are made from the following process:
- First, a malicious developer creates a token with no real use case, simply by copying and pasting code from another token and changing a few lines.
- The developer then adds liquidity to said token in a DEX like Uniswap.
- He begins to promote his token with great fanfare. Especially through social networks and influencers.
- As the value of the token increases, speculators experience FOMO and more and more users add tokens with real value to liquidity reserves, further driving the price higher.
- The malicious developer then drains all the liquidity from the platform and walks away with a lot of valuable tokens.
- Investors who did not abandon the project on time end up being spectators in a space without liquidity.
How to protect yourself from a Rug Pull?
There are a number of rules that allow us to protect ourselves from any scam, not just rug pulls. It is recommended to take precautions such as:
- Do not invest in anything you do not understand
- Don’t get carried away by FOMO on social networks
- Do not invest only based on technical analysis.
There are other measures to consider. Ignoring any of these can jeopardize your investments.
- Check the total existing liquidity. Legitimate tokens have tens of millions of dollars in TVL (Total Value Locked) locked. Too low an amount should be a red flag, implying a clear risk of rug pull.
- Unusual chart activity. If the graph indicates sharp movements in price and volume, there are probably whales (people with a lot of money) manipulating the value of the token, which translates to little decentralization.
- Unknown or anonymous community. If you had to identify some of the people working on the project and you can’t find anyone (no LinkedIn profiles, company ID, etc) they probably don’t want to be recognized for a reason.
Always do your own research. This is the mantra of the crypto community, and we cannot ignore the reason. The lack of regulation makes DeFi a dangerous jungle. There is no substitute for good first-hand research.