The Anatomy of a DeFi Rug Pull: How to Protect Yourself as an Investor

The Anatomy of a DeFi Rug Pull: How to Protect Yourself as an Investor

The Anatomy of a DeFi Rug Pull: How to Protect Yourself as an Investor

The Anatomy of a DeFi Rug Pull: How to Protect Yourself as an Investor

The Anatomy of a DeFi Rug Pull: How to Protect Yourself as an Investor

Table Of Content
Read Time: 5 minutes

Let us give you some hard facts. According to a report, we saw 1,548 Scam tokens deployed in the year 2020(sept. — Dec.), whereas in 2021 web3 community witnessed 83,368 scam tokens deployed. Let me highlight the whopping 117,629 scam tokens deployed in 2022. As we are advancing in terms of development in Web3, we are witnessing more and more scams and hacks. 

8% of all Ethereum tokens are programmed to be rug pulls. Due to the users’ lack of information or knowledge, it becomes easy for scammers to take advantage. With around 15 new scam tokens detecting every hour, the scam tokens or Rug Pull attacks are now a big threat Web3 faces. Surprisingly, even experienced and big investors have fallen prey to such scams. How can the people with not much experience protect themselves?

Looking at the upward trend of Rug Pull scams, this blog aims to teach you how the Rug Pull works and the process behind an expertly crafted rug pull. Later, we will learn about how you can protect your investments. Let’s start with a quick and short introduction to Rug Pull first.

What is a Rug Pull?

A Rug Pull is a scam in decentralised finance (DeFi) space. It revolves around developers or project teams of a DeFi protocol intentionally abandoning the project after raising funds and ending up taking away investments, causing investors a huge loss.

This scam is all about creating an illusion of a legitimate project, building hype, attracting investors, and executing their exit strategy. Rug Pulls have a devastating impact on the whole DeFi ecosystem, the result in significant financial losses and eroding trust in the DeFi ecosystem. Having quickly discussed the rug pull and its effect, let’s dive into the anatomy of Rug Pull.

Anatomy of Rug Pull

The Rug Pull involves several key elements and steps that scammers employ to deceive investors. These steps are taken to build trust and value of the token, only to pull the rug later. Let’s discuss the actions usually taken to scam using Rug Pull:-

  1. Project Launch: The first step in a scam token is to launch the DeFi project. This involves an appealing concept, promising high returns, innovative features, or unique tokenomics that attract investors.
  2. Hype and Promotion:- Marketing tactics to create hype around the project, various methods like employing influencers, social media campaigns, community engagement and partnerships to build credibility and attract investors.
  3. Token Sale and Liquidity Pool Formation: The scammers organise a token sale or initial liquidity offering (ILO) where investors can purchase the project’s tokens. They often offer incentives, such as early bird discounts or exclusive rewards, to make investors participate. Simultaneously, a liquidity pool is formed for the project’s tokens.
  4. Price Pump:- After the tokens are distributed, the scammers try to manipulate the token process. This can be done using your funds or using trading bots to help drive the price up.
  5. Building Trust and Community:- The very prime thing to build trust is to build a community. The scammers create a community, answer questions, provide project updates, and create an illusion of a dedicated team.
  6. Token Locking and Staking: Scammers may introduce token locking or staking mechanisms to deceive investors further. They encourage investors to lock their tokens in smart contracts for a specific period, promising additional rewards or incentives.
  7. Exit:- When scammers believe they have reached the desired threshold, scammers initiate rug pull. The exit mechanisms majorly involve various ownership-related vulnerabilities, which are put up intentionally by scammers only to exploit later. Common vulnerabilities like-
  • Owner’s accessibility to change the balance
  • Unlimited token supply
  • Changeable Buy/Sell tax rates
  • Access to pause the token transfers
  • Blacklisting of holders

Are usually found in the contracts, which are later used to scammers’ advantage.

  1. Price Collapse and Losses: With the scammers gone, the token’s price collapses rapidly, resulting in significant losses for investors unable to sell their tokens. The liquidity pool dries up, making it nearly impossible to exit the investment.

Checks for Investors

The above section discussed the chronology of a scammer’s success. Still, no matter how smart the scammers are, there are ways you can tackle such situations by carefully examining the project before making any investments. Let’s learn a few checks on how you can ensure you do not fall victim to such attacks:-

  1. Do thorough Research:-Conduct extensive research before investing in a project. Look at the team behind the project, their credentials, and past experiences. Consider the whitepaper, roadmap, and tokenomics. And always look for the ownership-related vulnerabilities mentioned in the anatomy section under the exit strategy; they are one of the biggest red flags.
  2. Project Transparency:-Transparency is the most crucial aspect of judging a project. If the project is not completely transparent, it will likely turn bad for investors. Check if the project’s smart contract code is available for public audit. Verify if the project has been completed or plans to undergo a security audit.
  3. Assess the project’s Community:- Community engagements mark trust and engage with the community through social media, forums or discord. The community should be active and wary if there’s a lack of community engagement or if the project team suppresses criticism or dissenting opinions.
  4. Auditing is Important: Projects with unaudited smart contracts carry higher risks. Audits from reputable firms, such as QuillAudits, help identify vulnerabilities or potential issues in code. Avoid projects with unaudited contracts or proceed with extreme caution, as they are more likely to be associated with rug pulls or hacks.
  5. Diversified Investments:- Diversifying investments across different projects helps to mitigate the risk, do not keep all your eggs in a basket. Diversification helps reduce the impact of any individual rug pull or project failure.
  6. Keep yourself updated on the project:- Follow the project’s official channels, including social media accounts and community forums. This allows you to be aware of any warning signs or sudden changes in the project’s direction.
  7. Start Small:- When entering a new DeFi project, start with a small investment to gauge its performance and stability. Gradually increase your exposure as you gain confidence and trust in the project. This approach helps minimise potential losses if the project turns out to be a rug pull.
  8. Be prepared to lose: Despite taking precautions, rug pulls can still occur. It’s important to mentally and financially prepare yourself for the possibility of losing your investment. Only invest funds you can afford to lose without impacting your financial stability.

Conclusion

12% of all BNB Chain tokens are scams, a haunting fact which is a reality, and the numbers are on the rise. Thus, it is very crucial to understand how such scammers operate and work so that you, as an investor, can protect yourself.

The above-provided anatomy provides a complete view of how scammers operate in today’s scenario, and the above section explores how you, as an investor, can be vigilant of such scams. It revolves around gathering trustable information on the protocol and constantly looking out for red flags, such as unaudited projects. 

If you are an investor or looking to invest in projects, it is very important to follow the checks mentioned above before investing and never invest in unaudited projects. Regarding auditing smart contracts, firms like QuillAudits provide the complete secuirty to the projects and release a trustable audit report which should be thoroughly checked before investing in any project.

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