What Is a Rug Pull and How Does It Work?

A rug pull is a term for a scam in the crypto space where traders are left hanging with worthless assets. Here’s how to avoid it.

Key Takeaways: 

• In the world of cryptocurrency, scams aim to deceitfully extract value, often using tactics like rug pulls.
  
• Rug pulls create hype around a new crypto or DeFi project, attracting traders, only to then abruptly withdraw funds, leaving the project worthless.
  
• Thorough research, scepticism of anonymous teams and third-party audits, and community engagement are vital for safeguarding against rug pulls.
  
• While cryptocurrency offers immense potential, it’s equally filled with risks, emphasising the importance of informed decisions.

What Is a Scam?

A scam is a fraudulent or deceptive scheme designed to trick individuals into giving away their money, personal information, and/or other valuable assets. Scammers use various tactics and strategies to manipulate their victims into believing they are dealing with a legitimate opportunity, service, or product, when in reality, their intentions are dishonest.

Scams take many forms, such as fake investment opportunities, phishing emails, pyramid schemes, identity theft, lottery and get-rich-quick scams, and more. They often exploit psychological triggers like urgency, fear, greed, or a desire for gain in order to manipulate victims into taking actions that benefit the scammer. 

What Is a Rug Pull? 

A rug pull is a term originating in the cryptocurrency and decentralised finance (DeFi) world. It refers to a malicious act where cryptocurrency project developers or insiders create a project or token, build hype, attract traders, and then suddenly withdraw — or ‘pull’ — a significant portion or all of the invested funds for themselves, effectively rendering the token or project worthless. 

This is akin to pulling a rug from underneath someone, leading them to fall.

How Does a Rug Pull Work in Detail?

Below shows how a rug pull may look in real life, from setup to the scammers disappearing with their victims’ money:

1. Setup: The scammers create a new, fake cryptocurrency/token or DeFi project. This often comes with all the features that real, trustworthy crypto projects offer: an attractive website, a white paper, and a roadmap that promises innovative features.
   
2. Marketing and Hype: The scammers or complicit shillers then aggressively promote the token or project on social media platforms like Telegram, Reddit, and YouTube, or via influencers and online forums.
   
3. Influx of Buyers: As the hype builds, unsuspecting traders buy into the project, increasing the value of the token or the amount of money locked into the project.
   
4. Withdrawal: Once the project has accumulated enough capital, the malicious actors suddenly withdraw the funds from the liquidity pool or project’s reserve, or execute a function in the smart contract that benefits them — to the detriment of others.
   
5. Disappearance: The developers and insiders then disappear, sometimes even deleting social media accounts, websites, and other traces of the project.

How Can Users Protect Themselves From Rug Pulls?

Below are some of the best practices to vet a project and which, when used alongside other protective measures, can help users avoid falling for a rug pull:

1. Perform Research: Always research a project before committing financially. Look for transparency in who the developers are (i.e., is the team publicly known?), their track record of past projects, and their reputation in the community.
   
2. Be Cautious of Anonymous Teams: Completely anonymous teams with no track record may be a red flag. While not all projects with anonymous teams are scams, it does add a layer of risk.
   
3. Audit Reports: Has the project had a reputable third-party audit? If so, read the report for any potential vulnerabilities.
   
4. Engage the Community: Participate with the project’s community on Telegram, Discord, and other channels. Ask questions and see what others are saying about the project. If the community seems closed and unwelcoming to questions, this is a potential red flag.
   
5. Limit Initial Investment: If unsure about a project but still tempted, consider initially trading a smaller amount of crypto. This will limit potential losses.
   
6. Check Liquidity: For DeFi projects, ensure there’s enough liquidity and that funds are locked for a reasonable time, which can prevent sudden withdrawals. This information is typically found in the white paper and smart contract. Also check if the smart contract code contains loopholes that allow the developers to withdraw all funds off the blockchain without warning.
   
7. Stay Updated: Scams evolve. Staying informed on the latest tactics can help users identify potential threats.
   
8. Employ a Healthy Dose of Scepticism: If it sounds too good to be true, it might be. Unrealistic promises or returns are generally red flags.

For more information, read our University article 7 Common Crypto Scams and How to Avoid Them.

Conclusion — How to Stay Safe in the Crypto Space

While the world of cryptocurrency and DeFi offers enormous potential for innovation and growth, it also carries the same risks as the traditional finance (TradFi) sector: malicious actors looking to take advantage of the uninformed. By performing DYOR, engaging with communities, and maintaining a healthy level of scepticism, traders can protect themselves from rug pulls and other scams. It’s essential to be well-informed and cautious when trading in any market, especially in rapidly evolving sectors like cryptocurrency.

Read our Essential Security Tips for best practices on protecting against scams and keeping accounts safe.

Due Diligence and Do Your Own Research

All examples listed in this article are for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, cybersecurity, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by Crypto.com to invest, buy, or sell any coins, tokens, or other crypto assets. Returns on the buying and selling of crypto assets may be subject to tax, including capital gains tax, in your jurisdiction.

Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a crypto asset, it’s essential for you to do your research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.