In the ever-evolving landscape of digital assets and blockchain technology, non-fungible tokens (NFTs) have attracted significant attention. However, as the popularity of NFTs continues to grow, so do the risks associated with them, such as NFT Rug Pulls. But what is a Rug Pull, how does it work, and how can you protect yourself? Read more about it in our article.
What is a rug pull?
In cryptocurrency, a rug pull is a scam in which a cryptocurrency or NFT developer promotes a project to attract investment and then shuts down or disappears, taking investors’ assets with them. There are variations on this theme, such as when developers deliberately hype up a project to raise the price and then sell it off sharply, causing the price to fall. The term comes from the saying “to pull the rug from under someone,” which in Russian sounds like “to knock the ground from under someone’s feet,” to leave a person in trouble. Rug pull scams are also known as “exit scams.”
How does NFT Rug Pull work?
Rug Pull schemes aim to artificially inflate the value of investments through false and misleading statements, with the goal of selling cheaply purchased assets at higher prices. Both schemes take advantage of the lack of regulation in the cryptocurrency space, misinformation, unethical sales practices, and FOMO (fear of missing out) among investors. The difference is that pump-and-dump schemes usually operate over a shorter period of time, focus on the price dynamics of low-value tokens, and do not require the involvement of token developers.
Another tactic is large-scale pre-mining, where tokens are issued before their public launch, which can either be hidden from investors or presented as a project treasury, developer fund, or burn. The scam is only revealed when these funds are quickly sold off once the token price rises sufficiently.
Rug pulling can be carried out through backdoors deliberately written into the project’s smart contracts, which allow developers to withdraw and manipulate staked or otherwise locked tokens. Whatever the mechanics, a rug pull quickly reduces the price to zero, leaving investors who did not exit the market earlier with useless tokens. Below, we will discuss the different types of schemes in more detail.
Types of rug pulls
In general, rug pull schemes fall into three categories.
Liquidity theft
Liquidity in cryptocurrency refers to the ease of conversion between two assets, such as trading between a digital token and fiat currency or another token. Liquidity pools allow users to trade cryptocurrencies without relying on a centralized exchange. Liquidity theft occurs when token creators withdraw all coins from the liquidity pool, thereby depriving the currency of all the value invested by investors.
Restricting or blocking sell orders or withdrawals
In this type of scam, developers usually allow investors to buy their tokens but either restrict or disable sell orders. They may restrict sell orders from the beginning of the investment period or much later when they want to lock in their profits.
This type of scam is more common on trading platforms where scammers have access to the backend to allow and prohibit trading or withdrawals. Such scams are usually carried out on decentralized exchanges to minimize the likelihood of being tracked.
Exchange users will be encouraged to use the new trading platform through an active marketing campaign. Once active trading begins on the exchange, fraudsters will partially or completely disable its functionality. For example, it will still be possible to buy tokens, but not sell them, or perhaps traders will still be able to sell limited volumes. There are several options, but ultimately the scammer’s goal is to walk away with as many tokens as possible.
Developers can also launch a smart contract for a crypto project with malicious code that restricts or prevents the transfer of tokens between wallets, thereby preventing token owners from selling them after purchase. This ensures that owners cannot send tokens to trading platforms for sale.
Token dumping
Token dumping means that developers promote a certain token to the public in order to raise its price. Investors will notice a sharp rise in the token’s price and may experience fear of missing out or FOMO, which will prompt them to invest. Once enough investors have been attracted, the promoters dump their tokens on the market at the peak, leaving the last buyers with tokens at an inflated price.
Another scenario occurs when the team behind a fraudulent crypto project allocates a disproportionately large number of available tokens to themselves as compensation for their role. These token holders, sometimes referred to as whales, then quickly dump these tokens onto the market, causing the asset’s price to drop.
Depending on how many tokens they have and how many of them they dump on the market, the price of the asset can drop significantly, resulting in losses for other token holders.
