For a person who is conversant with the crypto space, the term rug pull is not strange, however, crypto investors are on their toes looking for how to detect rug pull crypto projects and also finding ways to avoid crypto scams.
Rug pulls are a profitable fraud in which a crypto developer advertises a new project which usually is a new token to investors, gains investors’ trust, makes enough profit, and then vanishes with tens of millions or even hundreds of millions of dollars, leaving investors with a worthless asset.
Forms of rug pull
There are two forms of rug pulls: hard and soft.
Hard rug pulls
When project developers include malicious backdoors in their tokens, hard rug pulls occur. Backdoor exploits are secret exploits that the creators have embedded into the project’s smart contract. From the beginning, it is evident that the intention is to commit fraud.
Soft rug pulls
Token developers who dump their crypto holdings fast are referred to as “soft rug pulls.” As a result, the surviving crypto investors will have a highly devalued token. Dumping is improper, but it isn’t necessarily criminal conduct in the same way as hard pulls are.
To understand more about rug pulls, this article on top 10 crypto rug pulls gives a better insight on the topic. Now let’s delve into the purpose of this article.
How to detect a rug pull
When attempting to detect a rug pull, there are a number of things to keep an eye out for. Here are a few examples:
- Anonymous developers
- Unlocked liquidity
- Sudden/fake project
- Low liquidity
- Total value locked (TVL)
- No social media presence
- No audits
- Token distribution
The presence of anonymous developers on a crypto or DeFi project should indicate that something is wrong. The most successful cryptos of today, such as Ethereum and Solana, have a team of well-known leaders driving their growth.
If the creators of a cryptocurrency or DeFi project prefer to keep their names out of the public eye and remain anonymous, they may have excellent legal reasons for doing so, and you should probably avoid that coin.
Developers of well-known cryptocurrency projects may frequently relinquish management of the liquidity pool by enclosing it within their blockchain or entrusting it to a trustworthy third party to create trust and bolster public opinions of their legitimacy.
This is known as locked liquidity, and it stops developers from transacting any of the pool’s tokens, making it impossible to steal tokens or drastically lower liquidity. The longer the pool is sealed up, the less likely a rug pull will occur.
Rug pulls seem to appear out of nowhere, whereas legitimate cryptocurrencies and DeFi projects take years to build. These phony enterprises are frequently backed by a lot of hype, leveraging on currently popular cultural memes.
Low liquidity suggests that converting the token to cash is difficult, which could be due to the creator having limited funding to create the token. The developer can control the token’s price more easily if the liquidity is limited.
The best technique to determine a cryptocurrency’s liquidity is to look at its 24-hour trading volume. When compared to a reputable decentralized network, scam coins have surfaced with as little as US$10,000 in trade volume.
The trading volume should be at least 10% to 40% of the coin’s entire market capitalization, according to a conventional rule of thumb used by seasoned crypto investors.
Total value locked (TVL)
Total value locked (TVL) is another useful criterion for determining a cryptocurrency or DeFi project’s validity. This is the entire amount of money invested in a project. The higher the risk of a potential rug pull, the newer the project and the lower the TVL.
No social media presence
Scam tokens typically have a simple, low-effort website that was copied or thrown together in a matter of days. Some of these phony projects have false websites that say “work in progress” or “coming soon.”
These initiatives will also have no or a small number of social media accounts. A lack of genuine community participation on a crypto or DeFi project’s social media pages should also be a huge red flag for investors.
Independent security audits or financial transparency reports testify to the validity of the most well-known cryptocurrency initiatives. Cardano, for example, has passed many security audits as well as an independent source code audit. A project that lacks a third-party audit isn’t inherently dishonest, but it does indicate that you should do your homework before investing.
If a single wallet or two controls a significant portion of the token supply say, 5% or more selling all at once is simple, thereby increasing the danger of price manipulation or a rug pull.
While some of the aforementioned variables can aid in the detection of a rug pull, it is not 100% guaranteed that a particular coin or token will not be rug pulled. However, several precautions can be taken to avoid being a rug pull victim.
How to avoid Rug Pulls
Let’s break down some of the best techniques you can apply to your crypto research to avoid such frauds now that you know to detect a rug pull. Some ways to avoid rug pulls include;
- Using online resources
- Know the Team
- Exercising Caution.
- Read the Whitepaper
- Perform a background check
Using online tools
a. Token Sniffer
b. Rug Doctor
c. Etherscan or Binance Smart Chain explorer
To begin with, Token Sniffer keeps track of all the newest hacks and scam coins, so if you see a project on its list, you can be sure it’s a fake. Second, the site provides an automatic token audit, examining smart contracts, liquidity, and project similarity to provide users with a risk score for each token.
Rug Doctor The site examines the source code of crypto projects in order to find the most frequent rug-pull techniques. Rug Doctor publishes a list of high-risk token or DeFi projects on its website, including a risk assessment and a breakdown of the project’s red flags.
Etherscan or Binance Smart Chain explore
On these sites, a Token Tracker Page will show when you search for a cryptocurrency’s token address, usually under the More Info section. The tracker will show the overall supply, the total number of holders, and transfers, as well as Holders.
When it comes to new cryptocurrencies, if the top 10 wallets own more than 20% of the token, it’s a warning of a potential rug pull.
Know the Team
Scammers can make up phony founders and bios for their companies, therefore the best way to avoid being duped is to thoroughly examine the project’s specific team members before investing.
If you can’t locate any information on a developer or founder on LinkedIn or other social media sites, for example, that’s a red flag. Even if profiles exist, see if their activity corresponds to the number of followers and likes they have amassed. Individuals having thousands of followers but who rarely interact with them may not be genuine.
When looking for fresh investment options in the ICO and cryptocurrency industry, keep caution in mind. Be wary of undertakings that appear to be too good to be true.
Spend time examining every aspect, and consider that the lack of a critical piece of information could be an attempt to conceal an unsound model or concept. Before investing in a project, look for outside sources to verify its credibility, and constantly ask questions.
Read the Whitepaper
The whitepaper for a cryptocurrency or initial coin offering (ICO) is the project’s core document. Any blockchain-related project’s whitepaper should include the project’s background, aims, strategy, issues, and implementation timetable.
The first step in studying a whitepaper is to thoroughly read it. Check to determine if the whitepaper includes any other materials, such as financial models, legal problems, a SWOT analysis, and an implementation strategy.
Avoid companies that do not provide whitepapers at all costs. Even so, a phony organization could be able to present a plausible whitepaper.
A whitepaper should answer all of a possible investor’s questions about what sets this enterprise unique from its competitors, how it plans to succeed, and the steps it will take to reach its objectives.
Perform a background check
The first step in avoiding rug pulls is to thoroughly investigate the cryptocurrency project before investing. Never take a project seriously just because it appears to be official. It’s all about reputation, and only believe what you can verify. In crypto circles, the term “DYOR” (Do Your Own Research) is frequently recommended as a necessity for avoiding such scams.
How to Avoid Crypto Scams
To avoid crypto fraud, there are several common precautions that can be performed. These include the following:
- Don’t Trust Anyone
- Do Your Own Research (DYOR)
- Verify the URL
- Secure Your Crypto Wallet
- Use Multi-Factor Authentication
- Reject Fee Offers
Don’t Trust Anyone
Anyone who contacts you directly to beg for cryptocurrency payments or offers you a cryptocurrency investment opportunity should be treated with extreme caution. Do not trust emails from government authorities, celebrities, or anybody else who asks you to pay for something using cryptocurrency.
Do Your Own Research (DYOR)
It’s difficult to resist advice from billionaires and online influencers, but you should always do your own research before investing your money. Take nothing you read on the internet at face value. It’s usually a fraud if an investment sounds too wonderful to be true.
Verify the URL
Keep an eye on the URLs of any crypto-related websites you visit. Many phishing scammers replicate reputable websites’ URLs and change letters or digits. You should also check for a small lock symbol next to the URL to see if the site is secure.
Secure Your Crypto Wallet
If you possess cryptocurrency, never give out your private key or seed phrase. Instead, we recommend archiving the data in a secure location.
Use Multi-Factor Authentication
To keep your cryptocurrency wallet safe, use multi-factor authentication. As we’ve seen, it’s not a foolproof approach, but it does offer you a fighting chance against many assaults.
Reject Fee Offers
You may come across cryptocurrency offers that require an upfront payment. Reject them especially “offers” that require payment in bitcoin. Many of the cryptocurrency investment options are fake. You should read the company’s website for information on how they protect their consumers and look for feedback from other investors before investing anything.