What Is a Crypto Rug Pull? Definition and Meaning

Rug pull has become an increasingly common term used in finance and especially in relation to crypto. A rug pull involves a cryptocurrency scam that tries to profit from crypto investors. A crypto development team will usually develop a cryptocurrency with the aim of scamming early investors. By pumping the price of the cryptocurrency they developed and then making the funds disappear. Abruptly selling a large number of tokens is the most common type of rug pull. The extreme trading volume of developers trying to sell forces the price to collapse, leaving thousands of cryptocurrency investors with worthless coins, and huge losses. 

How do rug pulls work?

It has become increasingly more common for certain crypto enthusiasts to develop their own cryptocurrencies. These cryptocurrencies are then available to be traded on DeFi exchanges. These cryptocurrencies are then paired with well-known cryptos like Bitcoin or Ethereum. Investors are able to exchange these well-known cryptos for relatively new tokens. 

These crypto developers will try to market their crypto with the help of social media presence, and influencers. Due to the risks involved some of the promoters are even paid in the token that was developed. 

Cryptocurrencies traded on DeFi exchanges allow developers to list their tokens without any oversight. Developers can then use open-source protocols and effortlessly create a crypto scam.

Types of rug pull

A rug pull can happen in different ways, and for that reason, there are different types of rug pulls.

Dumping 

Dumping simply means that the developers or promoters who own a great percentage of the supply dump their tokens. As investors pile into this new cryptocurrency they exchange their valuable cryptos like Bitcoin and Etherum with the newly minted token. Developers and promoters will then retain a great majority of the supply for that token. When they finally decide to pull the plug by cashing out, they dump their worthless crypto that is thinly traded all at once. This makes the price at which the crypto was trading collapse to nearly zero.

Liquidity pull

Whenever a cryptocurrency is created the developers need to put up capital in the form of other more established cryptos like Bitcoin and Ethereum. Investors that wish to trade the newly minted crypto will have to exchange their Bitcoin or Ethereum in this example by the newly minted tokes. For those exchanges to occur the developers need to create a liquidity pool. 

A liquidity pull type of rug pull is when developers pull out the tokens in the liquidity pool. This can completely shut off the trading in the new token. Because crypto investors rely on the liquidity pool to buy and sell the new tokens. The liquidity pool is what allows them to exchange the cryptocurrencies they own with the new tokens. Therefore if the liquidity is reduced, they will not be able to trade their tokens, which eventually makes the price collapse.

Limiting sell orders

Some crypto developers purposefully develop the tokens with the intention of scamming crypto investors. Therefore they will include specific lines of code to limit the ability of retail investors to sell. Therefore controlling both the supply and demand. Of course, they are the only ones that are able to sell, and when the price has appreciated enough, and the timing is right they will dump all of their tokens creating a rug pull.

Why does crypto rug pulls happen?

The main driver of a rug pull is the extreme selling volume, relative to the average trading volume of a certain cryptocurrency. Although some developers plan this even before they launch their projects, it can also happen due to other reasons. As long as the sale volume is significantly higher than the average daily traded volume, rug pulls might happen.

Since some developers own a great percentage of the supply and cryptocurrencies in their infancy are very illiquid, anyone that tries to cash out could create a rug pull. 

Therefore the fact that some of these cryptocurrencies are thinly traded makes them susceptible to rug pulls. We had some insights into how this can happen, through Twitter. The thread explains in detail how crypto developers use influencers to reach out to their followers and pump worthless pieces of code to the moon. It also shows how malicious and ill-motivated some of the people involved in crypto are. Sparing no means and trying to defraud thousands of investors while advocating for financial progress through DeFi.

 

What does a crypto rug pull look like?

Well, we also have a video that shows how extreme the movements in some cryptocurrencies could be. Note that this is not volatility, this is in fact a scam. 

DeFi has exploitable risks

Cryptocurrency advocates will often praise decentralized finance (DeFi) as the road for global financial progress. The reality couldn’t be different. There are certainly advantages to decentralized finance, however, there are several risks that attract scammers trying to exploit them in any way they can.

The lack of regulation in the crypto industry continues to attract those willing to do whatever it takes to profit from naive crypto investors. One of the biggest trends over this year has been launching different cryptocurrencies related to trending themes. We have had Shiba, Islainu, and the most recent is squid alluding to the popular Netflix show Squid Game. 

Thousands of investors tempted by these get-rich-quick schemes commit their capital to these highly speculative and fraudulent cryptocurrencies. The greater fool theory plays out until as soon as developers or those holding a large number of coins try to cash out, and pull the rug.

Bottom line

More than ever these crypto scams are sprouting everywhere. As an investor, and someone that is interested in crypto you have to be aware and avoid these types of get-rich-quick schemes that only enrich the developers and those involved in the scheme itself. Crypto rug pulls have been a personification of how our financial markets currently work. A financial wild west that attracts inexperienced investors that are parting away with their capital at increasingly higher rates. 

Regulators should also be aware of this and should create policies to be able to oversee this new side of financial markets.

Image source: Youtube

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