What is a ‘Rug’ and How to Avoid Them？

2022-02-14, 09:31

【TR; DR】

Rug pulls have become a growing concern as cryptocurrencies have witnessed accelerated growth across the past few years. Various DeFi ecosystems have expanded， enabling thousands of developers and creators to develop their own cryptocurrencies， projects， and protocols - many of which have proved immensely valuable for their investors.

Yet， as the number of cryptocurrencies has skyrocketed， many have encountered currencies that have dissipated overnight, seizing their tokens and ultimately - their money.

These ‘rug pull’ projects have greatly impacted the finances and even lives of their investors， so it is integral to avoid them or mitigate the damages they may have on your portfolio.

What Is A ‘Rug’？

The term ‘rug’ bears semblance to the common English phrase ‘to pull a rug out’ from beneath someone， essentially referring to surprising or depriving someone of something suddenly. When placed in a crypto-context, a ‘rug pull’ means that those involved within the project have removed buy support or The Decentralised Exchange （DEX） liquidity.

Liquidity refers to how easy it is to sell an asset - if liquidity is low， it is harder to sell the asset or that if it is sold， then the transaction would detrimentally impact the price of the asset. Similarly， buying support means that new or preexisting investors are buying into a project， providing that they believe the asset is undervalued. When this integral factor is removed， the asset will continue to drastically decline in value， with no apparent floor.

‘Rug Pulls’ are often referred to as ‘exit scamming’ as they lead investors to rapidly attempt to sell their assets in order to salvage their finances， often with little avail， whilst developers of the platform can often gain a profit from the endeavour.

Typically ‘rug pulls’ are built through hype and immense publicity garnered by social media operations through platforms such as Twitter， Reddit， or Telegram， each of which enable communication between the so-called-DEVs and the investors. Promises of significant price rises and new features to their protocol often are enough to entice a range of investors， regardless of their experience.

‘Rug pulls’ often follow common tropes that investors have poured capital in across recent months. A crucial example of this can be seen through the gradual rise in ‘meme’ coins and animal-themed tokens， particularly considering the steep price inclines of assets such as DOGE and SHIBA in the latter quarters.

Many ‘rug pull’ instances have occurred when assets appear to have an inflated value and are rising in value alongside a bullish trajectory. This is primarily due to the lawless nature of DeFi platforms， which have enabled the development of thousands of cryptocurrencies at an advanced rate as a means of capitalising upon the flourishing ecosystem that is DeFi.

Why Are They Common？

Unfortunately， ‘rug pulls’ have become all too common across the DeFi space. Enabled by entirely decentralised platforms with limited or no regulation in regards to token development， cryptocurrencies built for the purpose of being a ‘rug’ are commonplace in these spaces.

A ‘rug pull’ is often built upon a detailed， yet malicious plan to gain money. Typically, these cryptocurrencies have liquidity injected into their pool to gain traction， particularly when paired alongside elaborate marketing schemes. As more investors pour their money into the token and generate further buzz surrounding it， the liquidity pool is immediately drained and the token essentially becomes worthless.

Typically， ‘rug pulls’ occur on platforms such as Uniswap and Binance Smartchain， due to the DEX available within their infrastructure. These DeFi platforms have contributed greatly to the accessibility of genuine， upcoming projects， yet they have also created an environment in which thousands， if not millions， of BNB or ETH are in the hands of the potentially-malicious.

What Are The Signs of One？

Whilst the DEX cryptocurrency development method has been vital in supporting several projects getting off the ground， the permissionless and lawless environment has fostered a divided community whereby genuine developers and those with ill-intent are often difficult to tell apart.

However， there are often some integral signs of a ‘rug pull’， many of which could potentially save your portfolio from being drained.

The Liquidity Isn’t Locked
Reputable tokens tend to always have their liquidity locked to avoid any potential misdemeanours and to ease the minds of investors. However， in order for a ‘rug pull’ to occur， liquidity must be unlocked and accessible at all times.

This enables developers to ascertain the amount of funds driving their project， allowing them to gauge the best time to drain the liquidity and reap the funds of investors. Often， the liquidity status of a trading pair is visible， meaning that if you have any doubts about a project， checking its liquidity status is an easy feat.

A Whale Holds A Vast Majority of Tokens
Most tokens have whales - even the likes of Bitcoin and Ethereum have major holders who hold significant portions of the token and continue to accrue gradual wealth as the market changes. However， a majority of ‘rug pulls’ have over 50% of the entire token pool absorbed by one or two primary whales， meaning that if they make a vast transaction， then the value of the cryptocurrency will significantly drop.

When searching through the blockchain information of a token， it is always integral to ascertain the volume of tokens held by primary addresses， as this can be a good means of assessing whether a project is a ‘rug pull’.

Projects That Promise Unrealistic Targets
Every developer wants their project to quadruple or rise by one thousand percent overnight - yet this often isn’t attainable. Recognising the need of many investors to make a ‘x10’ profit overnight， the developers of ‘rug pulls’ profit from the desires of investors and construct their plans to steal as much BNB or ETH as possible.

However， many ‘rug pulls’ will promise elaborate increases in value across a short period of time， with many even achieving this through the hype built by investors. Yet this often primes the market providing an optimal time to ‘pull the rug’ from beneath investors.

How Can You Avoid Them？

If you frequently visit the DeFi space， it may be inevitable that you will encounter a ‘rug pull’ project， however， following some of the advice outlined earlier may be enough to prevent you from being enticed by one.

It’s crucial to take caution when investing and to protect your best interests， instead of being susceptible to the plots of malicious developers.

Author：Matthew W-D, Gate.io Researcher
*This article represents only the views of the researcher and does not constitute any investment suggestions.
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