What Is a Rug Pull in Crypto & How To Protect Yourself From It?

Cryptocurrency is a young domain of potential and prosperity. Many new investors come in looking for significant gains and substantial returns. However, this sphere’s novelty is an advantage as much as it is a weakness. The ecosystem is riddled with scams and frauds, among which a crypto rug pull gained severe notoriety.

Rug pulls can affect anyone, from an entry-level crypto buyer to a seasoned veteran with years in the space. They can be difficult to spot, especially if you don’t know what to look for.

In this article, we’ll explain in-depth what a crypto rug pull is. We’ll review different types of this scam, check out the most notable examples, and examine how to protect yourself from them. Let’s get started!

What Is a Rug Pull?

Crypto rug pull is a type of fraud where scammers (usually developers) attract others to invest before suddenly taking everyone’s assets and disappearing. The term “rug pull” derives from “to pull the rug out from under someone.” It signifies a swift and unforeseen act that leaves affected individuals in a bad position.

These scams are prevalent in the space of decentralized finance (DeFi) due to a lack of regulation and a focus on self-custody. Many investors seeking high returns often resort to putting their assets in projects that haven’t been proven yet.

Even when investors act more responsibly, it can still be challenging to avoid rug pulls. The complexity of cryptocurrencies and blockchain technology makes it easy for malicious developers who possess the required knowledge to trick others by making a seemingly authentic and trustworthy project.

Firstly, there are two categories of rug pulls:

1. Hard rug pulls are planned beforehand, and project creators usually know in advance that they are going to scam their investors. To achieve that, they write their cryptocurrency’s code in a way that leaves it open to tampering from its developers.
2. Soft rug pulls rely on marketing tricks and trading maneuvers, not direct code manipulation. Essentially, developers and individuals involved with the scheme up the hype around a project to attract others and increase its price. Then, they exit the market with all the gains while leaving others to hold coins or tokens that have lost all value.

Soft rug pulls can be more subtle since project owners don’t have to plan for them in advance. They can happen in the middle of a stable project’s lifecycle after developers change their minds.

Types of Crypto Rug Pulls

There are three main types of crypto rug pulls. Understanding them can increase your chances of spotting these scams, so let’s examine each one.

#1. Dumping

Dumping is a soft crypto rug pull scam similar to pump-and-dump schemes. It involves project owners and close affiliates using marketing tricks and deception to increase interest and create a devoted audience around their cryptocurrency or NFT collection.

Some of the methods employed include paid advertising, being active on social media, employing influencers and celebrities, and participating in crypto-related discussions and communities. The goal is to build a reputable brand around a project that appears genuine, instilling trust in investors with the promises of big returns.

After outside investors buy into the project and raise the price of coins or tokens, original owners sell them for profit. Selling can last a few hours, quickly driving the price of the asset and “pulling the rug” under other investors. On the other hand, it can also take months of scammers slowly selling their holdings to make it seem like a regular market movement.

#2. Liquidity Stealing

Liquidity stealing is a hard rug pull scam that involves stealing funds from smart contract-locked liquidity pools. Most DeFi protocols (e.g., decentralized exchanges) require funds of cryptocurrencies to work. These funds are known as liquidity pools and are supplied by investors who earn portions of the fees paid by those who use the protocol.

Under normal circumstances, liquidity pools should be governed by smart contracts so that nobody can tamper with the system. That removes the reliance on centralized authority and ensures a fair system in which anyone can participate.

However, malicious project creators can add vulnerabilities that a regular investor might not be aware of to smart contracts. After liquidity pools are filled with cryptocurrencies, bad actors can simply exploit the vulnerabilities to irreversibly steal all the funds.

#3. Limiting Sell Orders

Limiting sell orders is another hard rug pull, meaning it also involves purposely corrupting the cryptocurrency’s code. Essentially, savvy developers can create a coin or a token with a feature that allows them to control who can sell it. Simply put, they can make it so that other investors can only buy crypto but not sell.

After enough people buy into their project, the original owners can then sell their assets while forbidding others from doing so. That way, they’ll get all the profit, drive the price down, and leave scammed investors with worthless crypto.

3 Examples of Crypto Rug Pulls

It’s estimated that there have been more than 700 crypto rug pulls and other scams, with more than $26 billion stolen by the end of 2023. Let’s check out some examples of the biggest and most notorious rug pulls in the DeFi space.

#1. Thodex

Thodex was the first and biggest Turkey-based centralized exchange. Its owner, Faruk Fatih Özer, was caught and arrested in Albania in 2022 following a massive rug pull in which he reportedly stole more than $2.5 billion.

The exchange was established in 2017 and quickly gained popularity due to the country’s native fiat currency, the Turkish lira, experiencing a rapid loss of value due to inflation. Investors started putting their money into crypto to mitigate the damages to their wealth. That resulted in Thodex having almost 400,000 users before its collapse.

Not long before the exchange’s crash in April 2021, Özer suspended all trading and withdrawals. It was later discovered that he had transferred around $125 worth of Bitcoin to another centralized exchange, Kraken.

He was sentenced to 11,196 years in Istanbul prison. Another six people were arrested, with an additional 21 facing charges.

#2. AnubisDAO

AnubisDAO was a liquidity-stealing rug pull that happened in 2021 amidst the hype surrounding “dog coins.” Looking to capitalize on the popularity of Dogecoin, anonymous developers created the ANKH tokens.

The project didn’t have a website or whitepaper, which should’ve already raised some red flags. However, it had a strong marketing campaign. The owners used Twitter (now X) and Discord to attract a large group of investors, promising to create a reserve-backed currency.

Their efforts paid off as the initial token sale garnered them 13,597 ETH, which was at that time worth around $60 million. However, all that Ether ended up in a liquidity pool to which the developers had access. They quickly transferred all the assets to another wallet and shut the project down. The perpetrators were never caught.

#3. Mutant Ape Planet NFTs

Mutant Ape Planet (MAP) NFTs was another rug pull designed to profit from the popularity of another successful crypto project—Mutant Ape Yacht Club (MAYC).

The creator behind the MAP collection, 24-year-old Aurelien Michel, advertised his NFTs as feature-packed digital assets. The owners were supposed to enjoy numerous benefits by holding their “Mutant Apes,” including access to rewards and other limited assets.

However, after selling all 9,999 NFTs, Aurelien and his developers withdrew all the funds, which were worth around $2.9 million. After transferring assets to another wallet, Aurelien even admitted to rug-pulling the community in a Discord chat.

After being arrested at the airport in New York, it was discovered that he might’ve been involved in several other crypto scams, such as Crazy Camels and Fashion Ape NFTs.

How to Protect Yourself From Rug Pull

There is no surefire way to protect yourself from rug pull. However, there are some steps you can take to minimize your exposure to it. Let’s find out what they are.

#1. Do Your Research

“Do your own research” (DYOR) is now a staple crypto adage that’s been proven time and again through countless projects and cryptocurrencies. Buying a coin, token, or NFT solely due to its good marketing or even a recommendation from someone without looking into its characteristics is considered a bad habit in the crypto sphere.

Many scammers are professionals in marketing and social media. Moreover, they often hire celebrities, internet personalities, and influencers to promote their product, knowing they have dedicated audiences.

Still, the best way to maximize your chances of avoiding a crypto rug pull is to look into the project yourself. Check out its whitepaper, the team behind it, tokenomics, goals, roadmaps, its social media presence, and any other bit of information that might show fraudulent intentions.

#2. Invest In Established Projects

A lot of investors look for brand-new projects and cryptocurrencies since they have the most potential to grow and provide astonishing returns. However, these projects also carry the most risk.

Investing in an established cryptocurrency that’s been around for a couple of years and has a proven track record is a much safer move. While there are no guarantees, long-term cryptocurrencies, DeFi platforms, and protocols are more likely to have actual value and not be simple crypto rug pulls.

And if you do want to invest in a new and risky endeavor, make sure only to use a small portion of your portfolio. In that case, even if you do get rug-pulled, it won’t have as big of an impact on your strategy.

#3. Diversify Your Investments

Speaking of portfolio management, it is generally considered good practice to diversify your investments in the realm of decentralized finance. The riskier the project, the less you should put in it.

As a general rule, you should never invest the money that you can’t afford to lose. That goes doubly so for sketchy cryptocurrencies and startup blockchain projects. By having a more significant portion of your portfolio in more secure assets, such as BTC, ETH, and stablecoins, you can set aside a smaller part for speculation without the risk of being liquidated.

#4. Avoid FOMO-Ing In

FOMO (Fear Of Missing Out) is the driving force behind many hasty and often poor investment decisions. The fast-paced crypto market is known for rapid movements, where coins and tokens can double in price overnight. In such a volatile environment, less experienced individuals often buy without thinking, fearing they’ll miss out on potential gains.

Bad actors intent on performing crypto rug pulls know about this phenomenon. They often market their project as if it’s quickly going to skyrocket in price, promising quick returns to those who invest as soon as possible. This should raise a red flag and incentivize you to approach their claims cautiously.

#5. Look for External Audits

External audits performed by reputable companies and knowledgeable individuals are one of the best ways to examine a project for its validity. Financial and blockchain experts can spot vulnerabilities much better than the average investor.

Before investing, look if a project has undergone any such audit. On the other hand, if the developers refuse to be audited, they are almost certainly scammers.

Are Crypto Rug Pulls Illegal?

Many crypto rug pulls are technically not illegal. There’s plenty of uncertainty and ambiguity surrounding crypto space in general, so that translates to these types of scams and frauds as well.

While rug pulls are deceptive and morally unethical acts, they are still in the gray area when it comes to legality. Moreover, rules and regulations differ between jurisdictions, which only makes it more difficult to bring the culprits to justice.

Centralized authorities are yet to implement clear laws regarding cryptocurrencies and fraud, including rug pulls. For instance, the SEC follows a set of rules to determine whether a digital asset is a security. Even then, these processes take time, and the outcomes vary.

Ultimately, while there has been an increasing number of arrests and trials for those who performed crypto rug pulls, a lot of these con artists are still free and even anonymous. Moreover, due to the permanent nature of blockchain, those who lost their crypto will likely never get it back.

Key Takeaways

That concludes today’s lesson on the more shadowy facet of cryptocurrencies. We’ve not only explained crypto rug pulls but given you concrete examples and means to protect yourself from them.

Going forward, you should remember to stay level-headed, suppress FOMO, and always do your research. That way, you’ll avoid most, if not all, scammers and fraudsters in the space. And if you ever feel that itch for gambling with a risky cryptocurrency, remember to only invest the amount you’re willing to lose!