NFT rug pulls happen when a type of fraud that occurs in the NFT space. Developers create a new token, list it on a decentralized exchange, and then abandon the asset, taking investors’ funds with them. This type of scam is especially common in the decentralized finance (DeFi) ecosystem.
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Decentralized Exchanges and Rug Pulls
Decentralized exchanges or DEXs are peer-to-peer marketplaces where token holders can directly transact with each other without giving up control of their funds. These transactions are facilitated through the use of self-executing contracts written in code, called smart contracts.
In the world of DeFi platforms, developers often carry out work on a blockchain that appears to be legitimate. This can include launching a working application and carrying out social media marketing. Once they have done this, they then issue a token and list it on a decentralized exchange.
Decentralized Exchanges are the perfect place for rug pulls to thrive because users can list tokens for free and without audit. Creating tokens on open-source blockchain protocols like Ethereum is also easy and free, which malicious actors take advantage of.
Security Flaws of Decentralized Exchanges
The main problem with DEXs is their distributed nature. Users of DEXs can take advantage of the fact that the development of the code is open source. With centralized crypto exchanges, the owners are likely to use their resources to build the software with their interests in mind.
Types of Rug Pulls
Liquidity Stealing
Liquidity stealing is when holders lose the value of their tokens because the token creators withdraw the entire liquidity pool. This “liquidity pull” happens after founders take all the money for themselves, leaving little or no money for anyone else — and in some cases, the result is a total token supply collapse.
This type of pull is the most common exit scam happening mostly in DeFi communities.
Limiting Sell Orders
Investors should be wary of developers who limit sell orders, as this can be a way to defraud them.
In this situation, the developer codes the tokens so that only they can sell them. Then, when retail investors buy into the new project using paired currencies, the developer dumps their position, leaving investors with a worthless token.
Dumping
Dumping refers to the act of selling off a large number of tokens all at once. This often happens when developers want to quickly get rid of their own supply, driving down the price of the project in the process. Those who are left holding the new tokens after a dump are often left with worthless investments.
Dumping usually occurs after there has been a lot of promotion surrounding a project on social media platforms. The resulting spike in price followed by the sudden sell-off is known as a Pump-and-Dump Scheme.
It is generally not considered unethical for developers to buy and sell their tokens. However, “dumping”, or selling a large number of tokens quickly, can be seen as a gray area ethically. This is especially true in the case of DeFi rug pull scams, where investors can lose a lot of money.
Top NFT Rug Pull Projects
Rankings are based on the total amount of money that was stolen in the process of the scam.
- Iconics — $140,000
- Fake Banksy NFT — $336,000
- Frosties NFT — $1.3 million
- Baller Ape Club — $2 million
- Evolved Apes — $2.7 million
- Azuki — $100,000,000+
How To Spot a Rug Pull?
NFT projects that have been around for a while tend to be more successful and have more consistent development than newer projects.
It can be difficult for someone who is not familiar with the industry to track red flags amongst the success of a project. However, experts suggest looking at the actual creators behind a project and their relevancy in the community as good indicators of a project’s viability.
A major characteristic of a possible scam is a marketing opportunity that promises unrealistically high returns for a short investment.
For example, a non-existent blockchain project promising a utility that will make you millions in a month or two. This trick is meant to drive FOMO which leads more people to invest in the token.
How Rug Pulls Happen
The popularity of scams can be attributed to their ease of execution. By creating new tokens on exchanges, scammers can take advantage of unsuspecting investors without having to go through a code audit. Code audits are important in smart contract development as they help to identify errors and potential vulnerabilities. Without proper evaluation, a developer could create a malicious bug that could allow them to steal user funds or conduct an exit scam.
Once a significant amount of unsuspecting investors register with the listed token, the creators then withdraw everything from the liquidity pool, driving the coin’s price to zero. The coin’s creators may even create a temporary hype around Telegram, Twitter, and other social media platforms to maintain investor interest.
Avoid Becoming a Victim of a Rug Pull
Decentralized exchanges use a pool system to set prices for tokens. This means that the price of a token can change depending on the amount of that token that is available in the pool. To make sure you don’t get scammed, it’s important to check the liquidity of a pool before you invest. However, this is only the first step. You should also check to see if there is a lock on the token’s pool. Most reputable projects will lock pooled liquidity for a certain period.
Liquidity pool
Rug pull scams are a common occurrence in the crypto world, and they often happen when a new project has low liquidity. This means that it can be difficult to convert the asset into cash. Seasoned traders avoid entering into projects with little liquidity because of the associated risks of unstable prices and price manipulation.
One way to check the liquidity of a project is by looking at its 24-hour trading volume. By doing this, you can get an idea of how easy it is to buy and sell the token, and whether or not there is enough demand to maintain stable prices.
Research The Project and Development Team
The best way to avoid being scammed by a rug pull is to do your research before investing in any project. Be sure to look into the reputation of the project and only believe what you can verify. Don’t assume that a project is legitimate just because it looks official.
Before investing in any NFT project, it is important to do your research and due diligence. Social media can be a great way to get to know the team behind a project and gauge public opinion. With limited tech expertise, social media platforms can be an accessible way to put a face to a name.
If you want to learn more about the project a good place to start is Twitter and Discord. There, you can find enthusiasts who are eager to talk about this niche topic. Once you identify the core team members, take a look at their social media accounts. You can also talk to people on the Discord server and get a better sense of the project’s mission. By participating in these discussions, you can gain a better understanding of the project’s social value.
Anonymity is a Red Flag
Many crypto projects are created by people who only disclose their pseudonyms. This type of anonymity can be problematic because it means that there is no way to hold these people accountable if something goes wrong with the project.
The blockchain space respects anonymity. However, checking if the orchestrator has a proven track record can help avoid potential pitfalls. Anonymity is often a scammer’s shield for easy rug-pulls. Checking for their proof of history is essential.
You should only invest in projects where the core team uses real-world names and credentials. This way, you can be sure that the team is made up of actual people, and not just avatars with funny names. If you can’t verify the identity or existence of the team members, it’s a red flag that should not be ignored.
Are Rug Pulls Illegal?
DeFi rug pulls have been in the news a lot lately, and many people are wondering if they are legal. While there is no easy answer, it is important to understand the different sides of the issue before making a decision.
Hard Rug Pulls
A hard rug pull happens when a project’s founder uses code to maliciously misuse the project to defraud investors. Hard rug pulls are illegal and can be very costly for investors. In most cases, the smart contract contains hidden terms in its code that are designed to trick investors into thinking they are getting a good deal when in reality the founder is intending to steal their money. The code serves as evidence of this intent to mislead and steal from investors.
Soft Rug Pulls
Soft rug pulls are not illegal but highly unethical. In a soft rug pull, the smart contract code is not designed to defraud investors, but there is still a possibility that investors could be stolen from or defrauded.
This usually happens when founders and their teams sell their assets quickly, which devalues the token and exploits the profit made by investors. An example of this would be a crypto project that promises to donate a significant amount of funds but instead keeps the money for itself.
Unruggable Projects
A project is only “unruggable” if there is a very small amount of tokens held by the development team. This means that there is little to no risk of a rug pull or exit scam, and the project can be considered safe.
There are many ways to approach an unruggable project. One way is for the team to renounce ownership of any tokens they would have acquired during a presale. This allows the team to focus on the project itself, rather than on any external rewards.
The End of NFT Rug Pulls
The ERC-721R standard for non-fungible tokens (NFTs) is the latest development that builds on the fee-saving capabilities of its predecessor, ERC-721A, and adds a new security feature. According to the standard’s website, ERC-721R allows minters to refund the cost of minted NFTs within a given period, which should prevent quick rug pulls.
ERC-721R is a smart contract template that enables a refund period for transferred funds. This refund period allows minters, or primary purchasers of NFTs, to get their money back while the smart contract owner cannot withdraw any funds.
It is important to note that the owners of a smart contract can set the refund price lower than the mint price. This means that buyers may not get their full investment back. While this option provides collectors with a sense of stability, it also protects genuine projects from flippers and unjustified refund rates.
The ERC-721R standard does not currently allow creators to withdraw any percentage of funds from the smart contract during the refund period. However, this may change in the future as the standard continues to evolve.
With the ERC-721R standard, creators can claim that their project is refundable within a certain period. However, the smart contract developer could still implement a secondary withdrawal feature that bypasses this protection. For your safety, it’s important to do your own research (DYOR) before getting involved with any project.
