A rug pull in the crypto industry is when a development team suddenly abandons a project and sells or removes all its liquidity
. The name comes from the phrase to pull the rug out from under (someone), meaning to withdraw support unexpectedly.
Rug pulls are most associated with Decentralized Finance (DeFi)
projects which provide liquidity to Decentralized Exchanges (DEXs)
. DeFi tokens of new projects usually aren’t listed on Centralized Exchanges (CEXs), meaning that a DEX is the only source of liquidity. Typically, a DeFi project will create their token and provide an amount as liquidity to a DEX. This may be put straight into a liquidity pool
(paired with another token like ETH
), or it may be sold in an Initial DEX Offering (IDO). In an IDO, investors will purchase the coin, and the proceeds will usually be locked for a certain period to guarantee a level of liquidity.
Once hype levels are high, and the project has access to their liquidity, the rug pullers have two options. They can either sell their tokens at a high price and remove all their liquidity or even use back doors in smart contracts to steal investors’ funds. Without sufficient liquidity, investors struggle to sell their tokens or are forced to sell them at a low price. This is due to the Automated Market Maker
(AMM) pricing mechanism that determines prices via the ratio of two coins in a liquidity pool.
Rug pulls are common in DeFi as tokens can be created easily and then listed on DEXs with little to no KYC
. Anyone can set up a liquidity pool, and even an IDO with basic due diligence checks still has a high level of risk. Many crypto projects are anonymous, making it easy for a team or owner to rug pull without risking their identity.
Common rug pull signs include a token price that rockets in a short amount of time without any protection on liquidity. If the project owners can remove their funds immediately or very shortly after the project’s launch, there is an opportunity for a rug pull. There will likely also be a lot of investor hype via Twitter, Telegram, and other social media platforms. To protect yourself from rug pulls, make sure to do diligent research on projects. This will include looking at the state of the product, its tokenomics, token distribution method, liquidity, and team. You can minimize your risk by making sure the above are all as transparent as possible and verifiable.