So let's use a hypothetical person called James, James a crypto investor who just put his savings into a new hot defi token the price of the token is already bullish he makes 10x, 50, 100x, 1000x in profit forgot to take profit before going to bed, while in bed he dreams of the Lambo he’s going to buy the new apartment he’s going buy and move into. James woke up the next morning to check the balance of his account he sees he is almost zero, what! How can this be possible he’s devastated it seems that James was part of a Rug-Pull?
Statistics show that from Jan. to Jul. 2021, about one hundred and thirteen million dollars (113$) were stolen via rug pulls which is the most common type of fraud in the booming Defi finance space. Since crimes in crypto are decreasing gradually there has been an increase in the Defi space.
HOW RUG PULL WORKS
Rug pull is a malicious scheme in which crypto developers create a worthless token/project and list it on a decentralized exchange, the token is traded against an established token let's say ETH or BNB. Attracting investors into the liquidity pool the scammers promote the project on social media promising a high yield of return of investment ROI, investors will then place ETH into the liquidity pool, which makes the price increase or be bullish at certain points the scammers pull the rug draining the pool of all the ETH leaving the investors with the worthless bag of the tokens and disappear with the funds. So which takes us to the question of how to spot a rug pull when you see one.
- Check the team background and social media
- Was the project audited
- Test your ability to sell
- Check the tokens distribution
- Check if the liquidity is locked
- Check independent audit websites.
Check the team background and social media accounts: This is a way of finding out information about the developers and the project if the developers are anonymous that’s a red flag, if it happens that the team information is available please check the reputation of the information and how solid the background is. Look out for social media and telegram chats ask difficult questions concerning the project if you are blacklisted, block or muted that’s another red flag.
Was the project audited: Legitimate project codes should be audited the project goes through a reliable third-party auditing firm who checkout for bugs, if a project is not audited you have to be very careful on investing cause these codes can be exploited to steal users funds. If the project was audited please make sure you read the audit.
Test your ability to sell: fraudulent projects have hidden codes in them preventing people from withdrawing from the pool, it is not advisable to put huge money into a project or a token until you know for sure if you will be able to sell i.e. you can run a test by putting one dollar in and taking the one dollar out same as you put twenty dollars in and take twenty dollars out if this is a success then you can proceed with your investment.
Check the token/project distribution: It’s already a red flag if a large amount of the tokens are in the hands of a few people (whales ) which means a bunch of whales who can dump the bag and crush the tokens price.
Is the liquidity locked: check if the token has a liquidity time lock, liquidity time lock is a security mechanism that is placed on the pool which prevents the developers to make away with your funds.
Check Independent audit websites: They are expert audit websites that will do the audit of Defi tokens they, in turn, break it down into metrics according to the rate of the tokens and the risk level.