As cryptocurrencies gain worldwide acceptance and more money flows into the space, fraudulent activities have increased. In particular, the Decentralised Finance (DeFi) ecosystem has attracted fraudsters as it is easier to start an enterprise.
Fraudsters take the ‘rug pull’ route to scam investors into fake projects and elope with their money. For example, in early November, the Squid Game token collapsed from a high of over $2,860 to zero as the team behind the token disappeared with $3.3 million in funds.
But as if investors learnt no lessons from the Squid Game token scam, they were conned over $1,157,125 last week after developers of Tsuzuki Inu allegedly rug pulled all liquidity from the project. Knowing how these scams are orchestrated and ways to spot the red flags is vital for investors to avoid losing their money.
What is a rug pull?
Usually, the modus operandi to create a rug pull project begins with the developer creating a cryptocurrency or a DeFi project to attract investors.
The next step is to make the cryptocurrency tradeable. Further, developers create a liquidity pool that allows the investors to buy and sell with the newly minted native token and a well-accepted cryptocurrency like Ether.
After the project is established, marketing gimmicks kick off with social media, Telegram channels, and influencer marketing promotions. Then, buyers start investing in the project by exchanging their ETH or any legitimate currency that will remain locked up in the liquidity pool for a certain period. With more scam tokens bought, their value keeps increasing, and more ETH comes into the liquidity pool.
Once a substantial amount is accumulated, the developer removes ETH from the liquidity pool, leaving the investors with a bag of worthless tokens. The scam is complete as investors can’t trade back their scam tokens and have lost their ETH.
Inability to cash out
In this alternative rug pull model, investors can buy the fake coins but cannot sell them on the exchange because of the developer’s fraudulent piece of code. As the project becomes popular owing to its exaggerated value proposition, investors realise that they can’t sell their assets. Ultimately, the scammers behind the project sell their scam tokens and leave the project.
The infamous Squid Game token, which increased by more than 40,000%, had users complain that they couldn’t sell their tokens on the PancakeSwap platform. Eventually, after its founders cashed out, the Squid Game token crashed from $2,860 to effectively zero.
Spotting the red flags
It is recommended to DYOR (do your own research) to spot a rug pull project and stay clear of them to minimise risks while investing in cryptocurrencies. Below are the things investors must look out for:
Fake projects lack utility and mostly rely on marketing hype to attract investors. On the other hand, stable projects will have a detailed whitepaper explaining the purpose and long-term vision. For example, fraudulent schemes that appeared overnight might have a basic or a ‘coming soon’ website. Verify if the company’s whitepaper is authentic as there is a possibility it has been copied from another existing project.
Strong online community
One of the first things that investors need to check is the project’s social media presence and community on Telegram, Discord, Twitter etc. If the messaging on these channels is too pushy to lure people to invest in the ‘most promising crypto project,’ then that’s a red flag. Common tactics involve engaging a sceptical influencer to promote the project. Investors need to be mindful of how authentic the community is on these platforms. For example, are the community managers open to answering critical questions about the project, are investor concerns addressed?
Research about the team
What’s common in the rug pull projects is that anonymous or pseudonymous teams run them. So always check the trustworthiness of the team involved in the project. Are they recognised in the industry they come from? Do they have a background in creating businesses in a similar domain in the past? If there isn’t any legal information like the company’s records, founder’s background, information about their cryptocurrency, you need be cautious.
Among the things investors should look out for in a project are their partnerships. Are they associated with reputable companies, and how meaningful are these associations? For instance, Cudos has high-value alliances in the industry, including AMD, Algorand, and Ultra. In case you missed it, here are some of the recent partnerships we are excited about.
Before investing in a project, be cautious of short-term pumps and dumps. It is usual for token prices to shoot up with announcements like new partnerships, exchange listings, or other significant developments. But if the price of the token skyrockets within a few hours without any reason, you must be careful.
Lastly, identifying a project as rug pull isn’t straightforward or limited to checking these boxes. As the DeFi space explodes, there is a thin line between a fraudulent project and the next meme coin. Eventually, it comes down to your research and appetite for risk.
Support impactful crypto projects
Although many projects are launching every day, most of them are merely trying to ride the crypto wave without making a real impact.
Extend your support to projects that are sustainable and have real use cases. For example, at Cudos, we unite cloud and blockchain to make computing sustainably cost-effective.
Be a part of our vision. We need data centres and cloud service providers. If you can contribute to this goal, please reach out to us now for collaboration.
The Cudos Network is a layer one blockchain and layer two computation and oracle network designed to ensure decentralised, permissionless access to high-performance computing at scale and enable scaling of computing resources to 100,000’s of nodes. Once bridged onto Ethereum, Algorand, Polkadot, and Cosmos, Cudos will enable scalable compute and Layer 2 Oracles on all of the bridged blockchains.