The Dangers and Prevention of Rug Pulls - Must-Know for Crypto Assets Investors

In recent years, with the rise of Crypto Assets investment, various scams have emerged. One of the most common types is the so-called "rug pull." According to statistics, in just 2021, rug pull scams deceived victims out of approximately $2.8 billion in Crypto Assets, accounting for 37% of all Crypto Assets scam revenue that year.

What is even more concerning is that this trend does not seem to be slowing down. In April 2023, the DeFi industry once again encountered a series of rug pull incidents, resulting in investor losses exceeding $6.2 million. Shockingly, these losses involved 32 different projects.

In these events, BNBChain became the most severely affected chain, with losses amounting to $4.5 million, accounting for more than 73% of the total losses. Following closely are Ethereum and Arbitrum, which lost $1.05 million and $182,000 respectively.

Definition and Types of Rug Pull

Rug Pull is a common fraud method in the Crypto Assets field. Typically, project developers suddenly withdraw funds from the liquidity pool of a decentralized exchange (DEX), causing the coin price to plummet; or they exploit centralized authority and logical vulnerabilities to abscond with investors' funds without any warning. This behavior is particularly prevalent in the DeFi space.

A recent suspected Rug Pull incident occurred on April 26, 2023. The decentralized exchange Merlin in the zkSync ecosystem was attacked, resulting in a loss of approximately $1.82 million. According to on-chain data monitoring, shortly after Merlin launched its three-day presale event, Crypto Assets worth about $1.82 million, including USDC and ETH, were stolen from the protocol due to malicious developers exploiting a vulnerability to implement the rug pull. As of the time of publication, this incident is still under investigation.

Rug Pull can be mainly divided into three types:

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 instantly become worthless.

2. Restricted Sell Orders: Developers impose restrictions through code, so that only they can sell the tokens. When retail investors purchase enough tokens, the developers will sell off their holdings, leaving behind a bunch of worthless tokens.

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

How to Identify and Avoid Rug Pulls

To avoid becoming a victim of a Rug Pull, investors need to pay attention to the following warning signs:

1. Unknown or anonymous development team
2. Lack of liquidity locking mechanism
3. There are restrictions on sell orders
4. The number of token holders is limited, but the price skyrockets.
5. Suspicious high yield promises
6. Lack of third-party auditing

In addition, investors should also:

• Check if the project is open source and has undergone strict auditing
• Understand whether the project has relevant security measures and emergency plans.
• Confirm whether the project has the authority to arbitrarily transfer user funds.
• Check whether the project permissions are overly centralized, preferably using management methods such as multi-signature or time lock.
• Verify whether the token allocation in the white paper aligns with the actual issuance.

Due Diligence Before Investment

Before investing in any Crypto Assets project, it is essential to conduct thorough due diligence. Investors should:

• Gain an in-depth understanding of the background and experience of the project team
• Carefully read the project's white paper and other technical documents.
• Check whether the smart contract has been audited by a reputable third party.
• Be wary of marketing tactics that overhype and create a sense of urgency.
• Assess the long-term sustainability and practical application value of the project.

Conclusion

Rug Pull has become a major ailment in the Crypto Assets world, resulting in huge investment losses. By understanding how it operates, identifying danger signals, and conducting thorough due diligence, investors can significantly reduce the risk of being scammed.

With the continuous development of the encryption industry, individual investors, regulatory agencies, and law enforcement must work together to prevent and combat such fraudulent activities. Only in this way can we establish a more secure and transparent Crypto Assets ecosystem, laying the foundation for future innovations and developments.