A rug pull is a scam in the cryptocurrency industry where malicious actors pose as creators or developers of a project with the intention to essentially take all the funding for a project and leave. The term refers to the saying of one having a rug pulled out from under them.
With rug pulls, which are prevalent in decentralised finance (DeFi), where many developers are anonymous, a developer or creator of a project launches their token on a decentralised exchange (DEX) and forms a liquidity pool. Once users purchase the token, growing the liquidity pool and market cap, the developers drain liquidity from the project, taking all the money.
Once that occurs, they close all community channels and shut down their social media to stop individuals from questioning them. Rug pulls predominantly happen on DEXs because, unlike centralised exchanges (CEXs), there is no screening process for a token to be listed, and anyone with the knowledge can list one themselves.
Understanding and recognising the signs are essential to avoiding rug pulls. For example, the token’s creator could artificially pump the asset’s price to entice other potential traders to add funds — and then pull the rug.
Another potential risk factor worth checking is whether the liquidity pool is locked and for how long. Typically, during a rug pull, the developer removes all the liquidity in the liquidity pool, essentially taking all the money and making it untradeable. Knowing if the liquidity pool is locked and for how long will help users know if the project is safe.
Token allocations are another way to identify potential rug-pull projects. If the developer team is reluctant to show the token allocations, or if they offer but it’s relatively high, users should be careful, as it could mean the developer holds a large portion of the tokens. This could also lead to them dumping the tokens, flooding the market, and tanking the token’s price.
For more information on rug pulls, read our University article.
