What is a rug pull in crypto and how to avoid it

Rug pulls in crypto: Meaning, origin and context

The term ‘rug pull’ originates from the phrase ‘pulling the rug out from under someone,’ meaning to suddenly withdraw support and leave someone in a difficult position. In cryptocurrency, a rug pull occurs when developers or creators of a crypto project suddenly abandon it and disappear with investors' funds, leaving token holders with worthless assets.

This type of scam became particularly prevalent with the rise of decentralized finance (DeFi) platforms, catalysed by pandemic-era stimulus, starting around 2020. The ease of creating tokens on blockchain networks like Ethereum, combined with minimal regulatory oversight, created an environment where malicious actors could launch projects, attract investment and vanish within days.

Rug pulls differ significantly from other crypto scams. Unlike Ponzi schemes, which promise returns from new investor money while maintaining an operational facade for extended periods, rug pulls involve an immediate or sudden exit by developers. 

They're also distinct from phishing attacks, which trick users into revealing private keys or passwords. In a rug pull, the scam is embedded in the project's structure itself, often through malicious smart contract coding or centralized control mechanisms that allow creators to drain liquidity or mint unlimited tokens at will.

The decentralized nature of cryptocurrency makes rug pulls particularly devastating. Without any centralized oversight or the ability to reverse blockchain transactions, victims have little recourse once their funds are stolen. 

This combination of easy project creation, anonymous developers and irreversible transactions has made rug pulls one of the most common exit scams in the crypto space, costing investors billions of dollars collectively. Maintaining personal financial sovereignty comes with significant advantages but also several risks. This is one of them. 

How do crypto rug pulls work?

Crypto rug pulls typically operate through three primary mechanisms, each exploiting different aspects of how cryptocurrency projects function:

1. Liquidity theft – When developers create a new token, they typically pair it with an established cryptocurrency like Ethereum in a liquidity pool on a decentralized exchange. Investors trade their established crypto for the new token, adding more value to the pool. In a liquidity rug pull, developers who control the liquidity pool suddenly withdraw all the paired cryptocurrency, leaving the new token with no trading value. Since the liquidity isn't locked, or is controlled by developer wallets, this drain happens instantly, and the token price collapses.

2. Developer exit scams – Involves the project team simply disappearing after raising funds. This often occurs after an initial coin offering, token presale or new NFT mint. The developers promote the project heavily, collect investments, then delete social media accounts, shut down websites and abandon the project entirely. 

3. Pump and dumps – Developers and insiders hype a token through social media, influencer partnerships and aggressive marketing to artificially inflate its price. As retail investors pile in during the ‘pump’ phase, insiders who hold large token allocations sell off their holdings at peak prices, causing the price to crash. 

While insiders can argue that they were simply selling their legitimately held tokens, the intent to deceive investors for profit makes this a form of rug pull, especially when combined with false promises about project development.

Crypto rug pull examples: The biggest cases so far

There have been several high profile cases over the years, with the following ordered by amount lost:

Squid Game Token (SQUID)

In November 2021, the Squid Game token rode the hype of Netflix's popular series, skyrocketing to nearly $2,900 within days. The project promised a play-to-earn game based on the show, but investors soon discovered they couldn't sell their tokens due to restrictions embedded in the smart contract. 

Developers then drained $3.38 million from the liquidity pool and disappeared, leaving the token worthless. The website and social media accounts vanished overnight, making this the textbook example of a liquidity theft rug pull.

AnubisDAO

In October 2021, AnubisDAO executed one of the fastest rug pulls in crypto history. The project raised approximately $60 million worth of Ethereum in just 20 hours before the developers drained the funds. 

What made this case particularly shocking was the speed. Most rug pulls build momentum over weeks or months, but AnubisDAO collapsed within a day of launch. The anonymous team provided no documentation, whitepaper or substantial project details, yet still attracted massive investment due to DeFi hype.

Luna Yield

Luna Yield performed a rug pull in April 2021, stealing approximately $6.7 million from investors. The project positioned itself as a yield farming protocol on Binance Smart Chain and attracted investors with promises of high returns. 

After accumulating substantial deposits, developers exploited a backdoor in the smart contract to drain all the funds. The team's identities were anonymous, and they vanished completely after the theft, again highlighting the dangers of projects with unaudited contracts and unknown developers.

Thodex

While technically an exchange exit scam rather than a DeFi rug pull, Thodex deserves a mention as one of the largest cases. In April 2021, the Turkish cryptocurrency exchange suddenly shut down operations, with its founder fleeing the country. 

Approximately $2 billion in user funds disappeared, affecting hundreds of thousands of investors. This case demonstrates that rug pulls can occur even on centralized platforms when proper regulatory oversight and security measures are absent.

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Meerkat Finance

Meerkat Finance stole $31 million from users within 24 hours of launching on Binance Smart Chain in March 2021. The project was a fork of Yearn Finance, a legitimate DeFi protocol, which gave it an air of credibility. 

However, developers exploited vulnerabilities they had intentionally coded into the smart contracts to drain all deposited funds. Interestingly, the developers later claimed they were ‘testing’ security and returned some funds, though this appears to have been a response to public pressure and potential legal consequences rather than genuine remorse.

Are crypto rug pulls illegal?

Surprisingly, the legality of crypto rug pulls is a complex grey area that varies significantly by jurisdiction and the specific circumstances of each case. In principle, rug pulls that involve intentional fraud, misrepresentation or theft are illegal in most countries, but prosecuting those involved can be challenging, especially as crypto regulatory frameworks are not fully developed globally.

In the United States, rug pulls can potentially violate securities fraud laws, wire fraud statutes and various state level financial crime regulations. 

The Securities and Exchange Commission (SEC) has increasingly taken action against crypto scams, while the Department of Justice (DOJ) has also prosecuted several high profile cases. However, enforcement is complicated by the anonymous nature of many crypto projects, the use of offshore entities and the technical difficulty of proving intent to defraud versus simple project failure.

For perspective, the distinction between intentional fraud and legitimate project failure is legally significant. If developers can argue that they attempted to build a real product but failed, or that they sold their tokens for personal reasons without intending to deceive, prosecution becomes much harder. This ambiguity is why many scammers operate with some degree of impunity, especially when launching projects from jurisdictions with weak regulation.

Internationally, the legal landscape is even more fragmented. Some countries have virtually no crypto regulation, making them safe havens for scammers. Others have pursued rug pull cases aggressively. The cross border nature of cryptocurrency means perpetrators can often evade justice by operating from multiple jurisdictions simultaneously.

Recent legal actions show authorities are becoming more sophisticated. For example, the DOJ charged the founders of the Frosties NFT project with conspiracy to commit wire fraud and money laundering back in 2022. However, the vast majority of rug pulls remain unprosecuted, and recovery of stolen funds is extremely rare.

Red flags and warning signs

There are usually red flags when it comes to rug pulls, and especially Initial Coin Offerings:

• Anonymous or pseudonymous developers – Legitimate crypto projects typically have publicly identified teams with verifiable experience. Anonymous teams face no accountability if the project collapses or turns out to be fraudulent. Always research team members on LinkedIn, Twitter and GitHub to confirm their track records and involvement in prior credible projects.

• No liquidity locks – Developers should lock liquidity for a set period using a time-lock contract to prevent them from draining funds. If liquidity isn’t locked, or if it’s only locked for a very short period, they retain the ability to rug pull. If they believe in the asset, there is no reason not to have a long lock-in.

• Unaudited smart contracts – Smart contract audits by reputable firms (for example, CertiK, ConsenSys Diligence or Trail of Bits) are crucial for identifying vulnerabilities or hidden backdoors. A lack of an audit is a major red flag, particularly for projects handling user funds.

• Skewed tokenomics – If insiders or developers hold 50% or more of the total token supply, they can dump their tokens and crash the market. Look for fair token distributions, with team allocations that are modest or subject to vesting schedules, with larger portions going to community and liquidity pools.

• Excessive hype and influencer marketing – Rug pull projects often rely on paid influencers, celebrity endorsements, and ‘get rich quick’ messaging. Be wary of promises of guaranteed profits, rapid returns or aggressive FOMO tactics. Legitimate projects are built on technology, real-world use cases and sustainable growth.

How to avoid rug pulls in crypto

Protecting yourself from rug pulls requires discipline. Following this systematic checklist, and resisting the urge to invest through FOMO, can help to reduce your risk:

Do your own research (DYOR) 

Thoroughly investigate every project before investing. Verify team identities and backgrounds through LinkedIn, Twitter and other professional networks. Read the new project’s whitepaper completely to understand its goals, technology and token economics. 

Check if the smart contract has been audited by reputable firms and review the audit report for any concerns. Also examine tokenomics for red flags like excessive insider holdings or unlimited minting capabilities, and review the project’s GitHub repository to confirm active, transparent development. Research is arguably your most important shield against rugpulls.

Use trusted platforms

Whenever possible, invest through platforms that conduct due diligence on listed projects. Established, regulated exchanges vet tokens before listing, filtering out many obvious scams. While not a guarantee of safety, it adds an important layer of protection compared to unvetted, decentralized exchange listings. Be particularly cautious with new tokens on platforms that have no listing standards.

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Leverage smart contract scanners and tools 

Use services such as Token Sniffer, RugDoc and Honeypot.is to identify common rug pull indicators. These tools analyze contract code for issues such as missing liquidity locks, unrestricted mint functions, concentrated ownership, and trading restrictions. While not foolproof, they provide quick technical checks that can uncover potential scams.

Start small and diversify 

Limit your exposure by investing modestly in new projects. Never invest more than you can afford to lose and consider diversifying your holdings so that a single rug pull doesn’t jeopardize your overall financial position. If a project looks promising but uncertain, allocate only a small percentage of your portfolio.

Trust your instincts and stay skeptical 

Be wary of projects promising massive returns, applying pressure to invest quickly, or mimicking trendy concepts without substance. In crypto as in stocks, skepticism is a strength. Taking time to research properly may cause you to miss some short term opportunities, but it also protects you from losses.

FAQs about crypto rug pulls

What is a rug pull in crypto?

A rug pull is an exit scam where cryptocurrency project developers or creators suddenly abandon the project and steal investor funds. This typically happens through draining liquidity pools, disappearing after fundraising or dumping large token holdings after artificially pumping the price. 

Are rug pulls illegal?

Rug pulls are illegal in most jurisdictions when they involve intentional fraud, misrepresentation or theft. In the United States, they can violate securities fraud, wire fraud, and money laundering laws. However, prosecution is challenging due to the anonymous nature of many crypto projects, offshore operations and the difficulty of proving intent to defraud versus legitimate project failure. 

How do I know if a project is safe?

Analyse projects using multiple criteria, including verifying team identities and backgrounds, confirming smart contracts have been audited by reputable firms, checking that liquidity is locked for reasonable periods, analyzing tokenomics for fair distribution without excessive insider holdings and researching the project's development activity on GitHub. 

What happens if you fall for a rug pull?

Unfortunately, recovering funds from a rug pull is extremely difficult. Blockchain transactions are irreversible, and scammers typically move stolen funds through mixers and multiple wallets to obscure the trail. You can report the incident to the relevant authorities, but the best approach is prevention through due diligence before investing.

What are the most famous rug pulls?

The most notorious rug pulls include Squid Game Token, AnubisDAO, Luna Yield, Thodex and Meerkat Finance. These cases collectively highlight the various methods scammers use and the devastating financial impact on their victims.

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