How one can stay cautious of rug pull scams in crypto

By Parth Chaturvedi

The driving force behind the increasing curiosity around crypto, lies in its underlying blockchain technology, which has been reshaping various industries and fostering a climate of continuous innovation. However, where there is boundless innovation, there also exists a potential for deceit. Just like any other asset class, crypto is not immune to scams. Among the various fraudulent schemes, one prevalent form is known as the ‘rug pull.’

Whether an individual is an experienced investor or a newcomer, being well-informed about these scams is crucial to protect their hard-earned money and avoid devastating losses. One invaluable rule to abide by in this pursuit is simple yet powerful: ‘Don’t trust, verify.’ This approach will enable investors to exercise due diligence and ensure they make informed decisions, while mitigating the risks.

Understanding Rug Pull Scam and its Impact

For those unfamiliar, a rug pull occurs when developers create a sham project, luring in unsuspecting investors with false promises, only to vanish with their hard-earned money. It is a despicable act that figuratively pulls the rug from beneath the feet of those who put their trust and financial stability on the line. In fact, just in the first half of 2023, a total of $75.87 million was reported across more than 110 rug pull incidents globally, according to Web 3.0 security firm, Beosin.

This figure doesn’t take into account what happened most recently on Coinbase’s new Layer 2 blockchain, Base, where the hype around a meme token—BALD. Its prices were pushed 4,000,000% in three days from issuance and attracted over $68 million in ether (ETH) and over $200 million in trading volumes. A retort on Coinbase’s founder Brian Armstrong, the BALD token’s deployers started to remove millions of dollars in liquidity from the token’s trading pairs in a sudden and unannounced move. This left thousands of holders in the lurch and caused prices to plunge as much as 90% in hours, as holders made a run for the exits. Interestingly, on-chain evidence is skewed toward suggesting that an Alameda-controlled wallet has interacted with the wallet used as a contract deployer; SBF and Co still making mischief in crypto land.

While some traps meticulously craft themselves to camouflage as genuine projects, others capitalize on trending events, using them as bait to attract investor attention. Another incident that stands out is the case from October 2021 when a group of anonymous developers exploited the global phenomenon of the South Korean TV show ‘Squid Games.’ They devised a scheme centred around a pay-to-play token, enticing investors with the promise of an online game inspired by the immensely popular series.

As a result, the Squid Games token experienced an astronomical surge, multiplying its value by a whopping 2,30,00,000% within just a week. However, once the price hit this peak, the scammers behind the scheme swiftly made their move. They decided to sell their holdings, triggering a devastating chain of events that sent the price crashing down. In a matter of minutes, the Squid Games token plummeted from its all-time high to a mere $0, leaving investors in a state of shock and uncertainty.

Red Flags to Watch Out For

However all is not lost and there are telltale signs of spotting such scams. An investor must stay aware of common tactics used by malicious actors and avoid any potential traps.

One crucial aspect to consider is token lock-up periods. Genuine projects that prioritize investor protection will implement lock-up periods, preventing developers from easily absconding with funds. These projects maintain transparency with the community, providing regular updates and outlining a long-term strategy (either on Twitter, Discord or Telegram)

Another sign to watch out for is when a project deliberately postpones or neglects the security auditing process. Legitimate projects prioritize security and transparency by having their smart contracts thoroughly reviewed by independent security firms before token listing or investor involvement.

Another red flag can be spotted when there are abrupt fluctuations in a token’s price history or trading volumes- It could indicate market manipulation. It is essential to exercise caution when encountering sudden price surges that lack significant news or updates related to the crypto project.

What Can Investors Do to Safeguard Their Investment

First, although DYOR or Do Your Own Research is important to remain unbiased, don’t hesitate to seek a second opinion. It is always beneficial to have another set of eyes and ears, whether it’s from trusted individuals or experts within the crypto community, when looking at new crypto projects for investment.

Secondly, when evaluating a project, dive deeper into the problem it aims to solve and the utility it offers. Take the time to analyze the project’s fundamentals. Always also try to verify the credibility of project founders and developers. Find out if the founders have substantial proof of work in the crypto industry and their track record. Look for open and honest communication, responsiveness to community questions, and a commitment to long-term goals.

One should also research about the supply and demand of the token, commonly referred to as Tokenomics:
Majority of the coins must be in circulation, if not make sure that the emission rate is high. (Recently launched WorldCoin is an example of very low circulating supply creating doubts in the mind of long term investors)

The tokens should be ideally allocated among various parties like VCs, early investors, the team, and the public.

Study what drives the token’s demand—utility, community, store of value, or benefits to hold. As the next step try to figure out how value accrues to the token (burning to reduce supply etc)

For Decentralised Finance projects, try to check the total value locked (TVL) in the project as it’s a good proxy for trust or “putting money where their mouth is”

Lastly, when trading digital assets, make sure to only use reputable compliant platforms that have a proven history of trustworthiness, and don’t list tokens just for quantity but focus more on quality of projects!

The author is investments lead, CoinSwitch Ventures

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