Rug Pull: Potential Risks and Preventive Measures in the Crypto Assets Field

In recent years, with the rise of the investment craze in Crypto Assets, various fraud methods have emerged one after another. Among them, Rug Pull has become a widely concerned type of fraud. According to statistics from data platforms, the losses caused by Rug Pull scams reached as high as $2.8 billion in 2021, accounting for 37% of the total revenue from Crypto Assets scams that year.

In April 2023, the decentralized finance ( DeFi ) industry encountered another Rug Pull incident, resulting in losses of over $6.2 million for investors. Shockingly, this incident involved as many as 32 projects. Among them, the BNB chain was affected the most severely, with losses of approximately $4.5 million, accounting for over 73% of the total loss. Ethereum and Arbitrum ranked second and third, with losses of $1.05 million and $182,000, respectively.

Definition and Types of Rug Pull

A Rug Pull is a type of Crypto Assets scam, often manifested when project developers suddenly withdraw the liquidity pool from a centralized exchange (DEX), causing the coin price to plummet; or by exploiting centralized permissions and system vulnerabilities to abscond with investor funds without any warning. This behavior is particularly common in the DeFi space.

On April 26, 2023, the DEX project Merlin in the zkSync ecosystem reportedly experienced a Rug Pull event, resulting in a loss of approximately $1.82 million. According to on-chain data monitoring, shortly after Merlin launched its three-day pre-sale event, crypto assets worth about $1.82 million, including USDC and ETH, were transferred out of the protocol due to malicious developers exploiting vulnerabilities to carry out the Rug Pull. As of the time of publication, the incident is still under investigation.

Rug Pull mainly includes three types: liquidity theft, limit sell orders, and dumping.

1. Liquidity Theft: This is the most common type of Rug Pull in the DeFi space. Project creators withdraw all tokens from the liquidity pool, causing investors' funds to lose value and the token price to drop to zero.

2. Limit Sell Order: Developers restrict through code so that only they can sell the tokens. After waiting for retail investors to purchase, the developers quickly sell off their positions, leaving behind worthless tokens.

3. Dumping: Developers sell a large amount of the tokens they hold in a short period of time, causing the price to plummet and the tokens in the hands of other investors to depreciate. This behavior usually occurs after strong promotion on social media and is also known as a "pump and dump" scheme.

How to Identify and Avoid Rug Pulls

Investors should be wary of the following six signs that may indicate a Rug Pull risk:

1. Unknown or anonymous development team: The team behind the project lacks public information or verifiable identity.

2. No liquidity lock: The token supply has not set a liquidity lock, and the project creator may take away all liquidity at any time.

3. Sell Order Restrictions: Some investors are unable to sell the tokens they hold.

4. Concentration of token holders and significant price volatility: If only a few people hold a large number of tokens, the price is easily manipulated.

5. Suspiciously high returns: If a project promises abnormally high rates of return, it may be a sign of a Ponzi scheme.

6. Lack of external auditing: A reputable third party has not formally audited the project code.

In addition, investors should also:

• Check if the project is open source and has undergone rigorous auditing.
• Understand whether the project has security measures and contingency plans.
• Verify whether the project has the authority to directly transfer user funds
• Confirm whether the project permissions are decentralized, using management methods such as multi-signature or time lock.
• Verify whether the token allocation in the white paper matches the actual issuance.

Conduct Due Diligence

To avoid becoming a victim of a Rug Pull, investors must conduct thorough due diligence:

1. Verify the credibility and past performance of the project team.
2. Carefully read the project white paper, website, and other relevant materials.
3. Check whether the smart contract code has been audited by a reputable third party.
4. Be wary of excessive hype and marketing tactics that create a sense of urgency.
5. Evaluate the practicality and long-term development prospects of the project.

Conclusion

Rug Pull has become a serious problem in the Crypto Assets world, leading to significant losses for investors. This article discusses the definition, types, and ways to identify and avoid this fraudulent behavior. Investors should learn to recognize potential risk signals, such as promises of high returns, anonymous development teams, lack of audits, and transparency.

Before investing in any Crypto Assets project, thorough research and investigation should be conducted. As the encryption industry continues to evolve, individual investors, regulatory bodies, and law enforcement must work together to prevent and combat fraudulent activities and maintain the healthy development of the market.