Rug Pull Explained: A New Type of Eyewash in the Crypto Assets Field and How to Prevent It

In recent years, the Crypto Assets market has been booming, attracting a large number of investors. However, this has been accompanied by various new types of eyewash, the most common of which is the "Rug Pull". According to data statistics, in 2021 alone, Rug Pull scams caused losses of about $2.8 billion, accounting for 37% of the total revenue from Crypto Assets fraud that year.

What is even more concerning is that this trend does not seem to be slowing down. In April 2023, the DeFi industry experienced multiple Rug Pull incidents again, resulting in losses of over 6.2 million dollars for investors, involving 32 projects. Among them, BNBChain was the hardest-hit chain, with losses reaching 4.5 million dollars, accounting for over 73% of the total losses. Following closely were Ethereum and Arbitrum, with losses of 1.05 million dollars and 182,000 dollars, respectively.

The Essence of Rug Pull

Rug Pull is an emerging encryption eyewash, typically manifested as project developers suddenly withdrawing liquidity pools from decentralized exchanges (DEX), leading to a sharp decline in coin prices; or utilizing centralized permissions and contract vulnerabilities to abscond with investors' funds without any warning. This behavior is particularly common in the DeFi sector.

Recently, a suspected Rug Pull incident that attracted widespread attention occurred on April 26, 2023, involving the DEX project Merlin in the zkSync ecosystem. According to on-chain data monitoring, shortly after Merlin launched a three-day presale event, approximately $1.82 million worth of USDC, ETH, and other Crypto Assets were transferred out of the protocol, suspected to be a Rug Pull executed by the developers exploiting a vulnerability. As of now, the incident is still under investigation.

Main Types of Rug Pulls

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

eyewash

This is the most common type of Rug Pull in the DeFi space. This occurs when the token creators withdraw all the funds from the liquidity pool. This action causes the funds injected by investors to lose value, and the token price drops to zero in an instant. The liquidity pool is a core component of DeFi protocols, allowing users to trade Crypto Assets without relying on centralized exchanges.

limit sell order

This is a more covert form of deception. Developers set restrictions in the token contract so that only they can sell the tokens. When retail investors purchase the new tokens with paired currencies, the developers wait for the price to rise to a certain level and then sell off their holdings, leaving worthless tokens for other investors.

dumping

Dumping refers to the project party quickly selling a large amount of tokens, leading to a sharp price drop, rendering the tokens held by other investors worthless. This behavior usually occurs after strong promotion on social media, forming a so-called "pump and dump" model. Compared to other DeFi Rug Pulls, dumping is in a moral gray area because developers buying and selling their own tokens is not illegal in itself; the issue lies in the speed and scale of the sales.

How to Identify and Prevent Rug Pulls

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

1. Unknown or anonymous development team
2. Lack of liquidity lock mechanism
3. There are restrictions on sell orders
4. The price of the limited coin-holding address is unusually volatile
5. Unreasonable high return promises
6. Lack of third-party audit

In addition, investors should also:

• Check whether the project is open source and has undergone rigorous auditing.
• Pay attention to whether the project has corresponding security guarantees and emergency measures.
• Assess whether the project's permission allocation is overly centralized.
• Verify whether the token distribution aligns with the description in the white paper.

The Importance of Due Diligence

Before investing in any Crypto Assets project, it is crucial to conduct thorough due diligence. Investors should resist the impulse created by hype and FOMO (fear of missing out) and take the time to research the project's background.

When conducting due diligence, the following issues need to be considered:

• Does the project team have a good reputation in the Crypto Assets community?
• Do they have successful project experience in the past?
• Has the project's smart contract been audited by a trusted third party?
• Does the project's white paper, website, and other materials provide sufficient information transparency?

Conclusion

Rug Pull has become a significant hidden danger in the world of Crypto Assets, causing huge losses. This article details the definition, types, and methods for identifying and preventing Rug Pulls. Investors should learn to recognize potential Rug Pull risks to protect their asset security. Before investing in any project, thorough research or seeking audit opinions from a professional team should be conducted.

With the continuous development of the crypto assets industry and attracting more investors, individuals, regulatory agencies, and law enforcement must work together to prevent and combat such fraud. Only then can a safer and more transparent investment environment be created for the crypto assets market.