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Let's say you're a new investor and take your investment to go in on the newest and hottest cryptocurrency without knowing too much about the crypto sphere. You just follow what you see on social media and buy a low market cap cheap token.
You see your initial investment double and then triple, sometimes tenfold, but when you check the following day, the price drops to zero, and you can't understand why you lost so much money, making you come to the conclusion of not wanting to trade cryptocurrency again. It is without any doubt that you might have been involved in what we call rug pull.
In this tutorial, I'll explain what a rug pull is so you can understand it easily.
What Is a Rug Pull?
A rug pull is a malicious scheme in which crypto developers create a worthless token and list it on a decentralized exchange. Here the new token is traded within a liquidity pool against an established token such as Ethereum to attract investors into the liquidity pool. The scammers use various ways to advertise the project, primarily through social media, by promising high returns.
As more and more investors put their valuable tokens in the liquidity pool, the price of the new token increases. At this point, the scammers pull the rug by draining the liquidity pool of all the valuable tokens and disappear with the funds. It immediately crashes the price of the new token leaving the investors with the worthless token.
There are three main ways this happens:
Yanking liquidity: Whenever a developer creates a token. They must create a way for new investors to trade that token, and to do so, they put a portion of a valuable token and a portion of their new token. Both of these go into a trading pool and allow new investors to give them the valuable token; in return, the investors will receive the newly developed minted token.
However, as time goes on and as more investors invest, the price of their new token increases and the developer can rug pull the token by pulling out their initial liquidity. By doing this, they don't just get back the initial amount of their new token, they also get more of the valuable token. This will lead to other investors being unable to trade because the liquidity pool will have nothing to allow a trade to happen.
Selling their shares: this is another way a rug pull can happen. A developer can sell their shares. They do this by creating a worthless token and then convince a large majority of people that their token is promising.
For example, they might say that they have a new platform releasing soon, and when it does, it will be the next big thing, So they sell this concept to a large number of investors, and then when the token price is high, sell all of the tokens that they issued themselves at the start of the token launch.
In short, what they did was to mint a worthless token, get people to trade a valuable token for it, e.g., BnB, Ethereum, and then run away with the valuable token that they convinced people to give them. This method sometimes happens slowly over time, so you won't think you're getting rug pulled. Others might happen swiftly.
Inability to sell: some token creators add some code to their tokens that will literally not allow users to sell their tokens back to the decentralized exchange. This means that users can buy but cannot sell them. That way, the price will only go up because nobody can sell their token even if they want to, and when the price is really high, the rug puller will sell all the tokens they gave themselves or bought earlier during the launch at a very low price.
Now that we know what a rug pull is let's go over some ways to avoid one.
Ways to avoid rug pull
Liquidity is not locked: Sometimes, to prove that the project is legitimate, many developers will lock up their liquidity with a trusted third party to ensure that they can't pull out that liquidity even if they want to. This is a good sign that the project will not get rug pulled. But you should know that the option for the price to be manipulated is still there. It is essential to pay close attention to how long it is locked.
Use blockchain explorers: Using blockchain explorers to Check if a few wallets have a large percentage of all the coins is another preventive measure. With blockchain explorers like the bsc scan or etherscan, you can see who is holding the majority of the token.
Check if the burn wallets have a large percentage: one trick many developers who rug pull will try is to create a ton of tokens, then they will burn a large majority of them. Burning means sending tokens to an address that nobody controls.
Audit: Audits done by third parties are good to look out for. If a project has multiple audits performed by a few trusted sources, it's a sign of not being a rug pull project. Projects with no audit are red flags.
No social media or website: Another red flag is when a project has no social media or website. This is because anyone wanting to make a quick buck can quickly create a token; however, it takes time to create a distinguished social media page and set up a website, so you definitely need to check those out.
No multisig wallet : A multisig wallet simply means if a whole team is working on a project, one person can't go and steal the private key and withdraw all the funds. Any transaction on this developer wallet will require multiple passwords from multiple people, decreasing the potential of one person getting greedy and running away with the funds.
Wrapping Up
In this article, we talked about what a rug pull is and how a rug pull can happen. We also talked about ways to avoid being a victim of rug pull. Following these steps will help greatly and save you from being rug pulled.