What is a rug pull?

Where does the term rug pull come from?

The literal translation is carpet pull. Here you visually think of a carpet, on which people are standing, being pulled so hard that these poor folks fall over.

In English, there is an expression "to pull the rug out." This means a quick action that leaves someone off balance.

Since there are multiple types of rug pulls we will create a general picture of what the terminology means: in a rug pull, the creators of a cryptocurrency or token get away with the money and these coins or tokens become worthless. In other words, it is an exit scam.

Main variants of the rug pull

1. Hard rug pull. In this, the makers of the coin encode a weakness in a smart contract that they devised to exploit it. Common tricks here include stealing liquidity in a pool or making selling coins impossible, except of course for the creators. This is illegal and punishable.

2. Soft rug pull. This is the best-known form, where creators first wait until there is enough money in the pot and then sell all their coins at market price, which means the coin almost always goes to 0 and never becomes worth anything again. This is unethical, but not illegal. Often creators still hype their coin on social media and through influencers to walk in a little extra.

Well-known rug pulls:

Squid Token, OneCoin, Thodex, AnubisDAO, Frosties, Baller Ape Club and SudoRare.

Creating a token for the purpose of a rug pull

Many cryptocurrencies work with open source. This means that anyone can use the code to create a new coin or token. Thus, if you are a little bit handy, anyone can create their own token in no time.

Commonly used markets are DeFi, meme coins, NFT, Web3 and the Metaverse. A total of billions are pulled every year.

Having created the token, it still needs to be marketed. Several scenarios are possible for this. Some developers put a lot of work into it, paying influencers to promote their token. Usually they then also use social media and tech channels to hype it up considerably.

Other creators find this already too much work. They want a quick fix from their bank account. So they take advantage of the weaknesses that exist in the crypto world.

Creating a regular coin with its own blockchain takes a lot of work. Then you still have to get them listed with a centralized exchange. A CEX has pretty high requirements, such as an audit and a nice entrance fee for the listen. This lowers the chances of buying a coin on a CEX that is going to be a victim of a rug pull.

A lot of tokens for a rug pull use Ethereum's network and very easily create an ERC-20 token via open source copycatting. Other variants are possible, but ETH is now very widely used on decentralized exchanges (DEX), such as UniSwap or SushiSwap.

Then they sell their coins via an IDO (initial dex offering) or they throw some money at it to get some liquidity in the token via a liquidity pair consisting of their token and a known coin, such as ETH or BNB. They may also simply have the token listen on a DEX so that it can be bought and sold through their contract there or on their website.

Sometimes there is still a time when the tokens are locked, giving them a chance to increase in value without being dumped.

Since there is no oversight of a DEX, anyone can just listen to tokens on it. Everything works through smart contracts and an AMM. This is very attractive to scammers. The trap is set.

How is a rug pull performed?

1. Liquidity stealing. On a DEX, you can deposit assets into a so-called liquidity pair. For example, you can deposit USD and PancakeSwap into a USD/PancakeSwap pair, where you are going to get interest for providing liquidity. Prices are set by an Automated Market Maker (AMM). In a rug pull, for example, the pair consists of ETH/Shitcoin. Shitcoin is made to perform a rug pull with. When enough people have deposited ETH into the pool, it starts to become attractive to turn the pool into a total Shitcoin pool. The creators of the DeFi tokens throw the pool full of their Shitcoin and snatch up the valuable ETH and greet Shitcoin owners from Malibu at the beach.

2. Dumping. This is a simple exit scam, where the developers of the token pull all the value out in a very short period of time. When a new token is introduced to the market, the creators sometimes keep a large portion of these tokens. This is usually a red flag because they can simply dump all their tokens whenever they want. They usually wait until there is enough money in the pot, whether after social media attention and using influencers or not. Sometimes they also use the pump trick. They buy so many of their own tokens, which still cost very little, causing their price to skyrocket. Once there is enough FOMO, large groups of unsuspecting investors get in. When they feel there is enough in the pot they sell all their tokens at market price, making any off-take price good enough. Once there are no more takers, the price is at 0 and usually no one has any use for the thing. The "project" gets ghost status.

3. Smart contract scam. When you buy a coin you do so through a smart contract on a DEX. Sometimes the developers have set up the smart contract so that you can buy coins, but not or very difficult to sell. This is only possible for certain wallet addresses, which of course are owned by the creators. You only find out about this when you also want to sell the tokens again. Often the creators try to buy some time with all kinds of excuses, but when too many people start complaining, it has become time to perform the rug pull. The developers sell their coins and leave the buyers with unsellable, worthless tokens. The Squid token scam is a notorious example of this. From a low value token it initially rose to thousands of dollars, then the developers, who could sell their tokens, became very rich.

What is an NFT rug pull?

Since the NFT is still very poorly regulated, developers of "special projects" can create an NFT series and try to lure investors into tokenizing NFTs.

Well-known series are CryptoPunks or Bored Ape Yacht Club, for example.

So you can create a series of images and turn them into NFTs, for example a series of crazy penguins or beautiful villas. Then you make it look as much as possible like a good investment and as little as possible like a scam.

To lure investors, you must first get on the whitelist to coin an NFT. This makes individual stakers feel honored and think this is something exclusive.

Then these investors start to coin NFTs at a predetermined price, usually in ETH.

The creators of the collection now have two choices: they perform the rug pull immediately after the coinage, or they wait to see if there is enough interest and prices rise. Either way, at some point they will remove all the valuable funds (ETH) from the pot and leave the NFTs worthless.

NFT rug pulls are becoming more common. They are also a bit more opaque than a rug pull with a token. This is because of the total lack of central control.

The difference between a rug pull and pump and dump

In a pump and dump, a coin with low liquidity and market capitalization is purchased little by little by the organizers. This keeps the price fairly stable. When they have purchased enough, they tell participants at a certain point: NOW!

The idea is that from that moment on, participants will all buy in together and let the price rise substantially. The moment the price begins to rise, after half a minute or so, the organizers dump their entire bag at market price on the market. This causes the price to drop tremendously. The organizers thus make a huge profit and the other participants are left with huge losses.

The organizers do not say in advance what coin it is about, they do say when it will happen. If this is the set-up you know they are scammers, because if they would mention the coin you could also buy in and that is not the intention. You should buy at the time they say.

How do you avoid becoming a victim of a rug pull?

• Invest in projects that are not likely to experience a rug pull. To do this, look at how many tokens are in wallets and whether that is enough to orchestrate a rug pull. If you see in a blockchain explorer that certain wallets hold more than 25% of the coins, then a dump of such a bag would collapse the price. Also look to see if the team has large quantities in their portfolio. A token where the developers have no tokens at all is quite safe, but remember that ordinary investors can also trigger a "rug pull," as long as they have enough tokens to send the price plummeting to 0.

• Assume that every project you research is a scam until you find evidence that it is not. That way you avoid looking deep enough into their glass through fancy marketing.

• Wait a while. Most rug pulls are done within a week.

• If the team is anonymous, it may be for very good reason. Namely, to be able to do a rug pull later without anyone knowing who they are. Unknown names also say pretty little, it may even be that these are fake profiles that are so made these days. Reliable profiles on LinkedIn from well-known developers give a project credibility. By the way, if Satoshi Nakamoto had wanted to trigger one, he's pretty late.

• How many of the tokens are locked? If all tokens are free to sell from Day 1, what's to stop someone from performing a rug pull if there is enough in the pot? There may be some activity in buying and selling, but liquidity needs to be somewhere around 75% minimum locked for years to be plausible. So look closely at tokenomics.

• The price of the token is flying in the air and there are very few holders. You can see this in a block explorer. This means that people are probably pumping until the price of the coin reaches a certain level and there are enough new investors to dump the coin. This could involve whales as well as developers.

• An unattractive website full of typos or implausible claims. The lack of a whitepaper, technical issues or even a purpose is also a red flag. If they show no activity on GitHub and it is a fork of another project, it's probably a scam.

• Suppose you are interested in a coin, you can buy a small amount first and try to sell. If selling fails then we are probably dealing with a fraudulent smart contract. Red flag.

• If there has not been an audit by a third party yet, no one can say if it is a legitimate coin either.

• Very high returns. If you can earn hundreds of percent per year or even more with a coin in, say, a liquidity pool, then it is more than likely a decoy. It then looks like a ponzi scheme or like holding out a sausage that you never get to eat because the pot is empty when it's your turn.

• External parties trying to push you with, for example, a limited time. Usually this is done to get people to invest as quickly as possible, without giving them time to think carefully.

• Invest in tokens with high liquidity. This is often a sign that it is a valid project, although this is not always the case. Back pullers are not known for putting large sums of money into their own coin.

• Focus on established projects.

• Avoid a DEX, on which one fraudulent coin after another appears. There is no KYC, AML or audits on a DEX. It is the best place to stay if you are a scammer.

Final thoughts

Unfortunately, rug pulls will always be a part of cryptocurrency. It may seem attractive to buy a token that is mooning or where you are promised golden mountains by developers or influencers.

Of all the tokens marketed, quite a few are made only to perform a rug pull with them and then leave the project.

There is no harm in spending very small amounts on new tokens, with the hope that you have found the new Dogecoin or Ethereum. At least then you can shrug when the rug pull is a reality.

If you are working with large sums of money, it is not a good idea to put it into new coins without doing thorough research. If you do, you could become the next victim of a common scam: the rug pull.