There’s an old adage about investing: if a project looks too good to be true, it probably is. This also applies to the cryptocurrency industry. One of the most popular scams used by cybercriminals are so-called “rug pulls”. The scammers trick their victims into investing in a project and then abruptly abandon it. Investors are left empty-handed, while developers have long since fled. However, there are a number of indicators that investors can use to spot potential scams and protect themselves. To understand when alarm bells should ring when investing in crypto projects, it is worth taking a look at the scam.
What are rug pulls and how do they work?
In the first phase of a rug pull, the scammers must manage to attract investors. Usually high yield promises are made. For example, the projects are promoted using deceptive marketing websites, fabricated roadmaps, or fake partnerships. In most cases, the scam project comes with its own token. Investors are blinded by high profit expectations and encouraged to buy tokens. This sometimes happens long before the project has even started. With presales, investors can get involved in the early phase of a project at particularly favorable prices.
Once the criminals have accumulated enough capital, the second phase begins. This can be designed differently in detail, but always leads to the same result. Investors are being robbed of their money. There are two common methods for doing this.
Soft pull vs hard pull
soft pulls: The developers of a crypto project can specify how many tokens should be minted. They can also control how many of their coins are issued to investors and what percentage they keep for themselves. The price of a token is sometimes influenced by how many coins are in circulation and can therefore be traded. In a soft pull, scammers hold a significant portion of the tokens themselves and then liquidate their holdings without warning. As a result, the price collapses and the investors’ tokens are only worth a fraction.
hard pulls: In hard pulls, the tokens were manipulated in a certain way. For example, using code snippets in the manipulated smart contract that make it impossible for others to sell the token (honeypots). Developers could also build a hidden way into the code to mint unlimited new tokens (Hidden Mints), or charge selling fees of up to 100 percent (Hidden Fee Modifiers). It is not uncommon for developers to also build so-called backdoors, i.e. hidden backdoors, into the smart contract in order to then flee overnight and withdraw all of the liquidity in a contract.
5 things Cryptocurrency investors should watch out for
When investing in crypto projects, there are a number of indicators that can point to a possible rug pull. Every investor should have these five red flags on their screens to avert possible fraud.
Exaggerated return promises:
Just as in the classic financial world, caution is also required in the crypto sector with projects that advertise extraordinarily high returns. Investors should assess the profitability of the project themselves and not let other players put dollar signs in their eyes. A look at the white paper and the roadmap can provide initial assistance. The rule of thumb is: high return equals high risk.
Anonymous Development Team:
Another cautionary tale is an unverified development team. Investors should conduct their own research to obtain information about the people involved. With rug pulls, the developers often remain unknown or appear on the project website with fake accounts. While an anonymous development team is not an exclusion criterion, it should alert investors. It is worth doing some research in this regard in order to identify any inconsistencies.
Online presence and social media:
The status of the project website and other channels of the project can also be an indication of a potential rug pull. A solid project usually does not save on the online presence. Websites of projects with fraudulent intentions serve as a front. A cheaply designed website or faulty functionalities should make investors prick up their ears. The same goes for social media posts. Strange or overly relativizing statements and texts with chatbot characteristics can be an alarm signal.
It is also useful to take a look at the distribution of the tokens in the project when making an investment. How many tokens are in circulation? How many of these do the developers keep? Are there any stocks that are frozen for a period of time?
You can find out everything about tokenomics in this article.
The smart contract:
An examination of the smart contract on which a token is based is also recommended. Of course, checking the code yourself is beyond the expertise of almost all investors. Nevertheless, a check can also be useful at this point. For example, it is positive if the code is open source. So it is visible to everyone. If you are not able to read the code yourself to identify possible loopholes, you can at least fall back on the expertise of a third party. In addition, there are some companies that specialize in evaluating the code and who use audits to examine smart contracts for possible risks. As with all other investment indicators, the same applies here: “Do your own research!”