Crypto projects have evolved considerably over the past few years, as the popularity of digital assets has boomed. Besides Bitcoin, the number of altcoins expanded beyond Ethereum, with utility, governance, and meme tokens gaining the attention of regular and institutional investors.
Unfortunately, this growth also attracted the attention of malicious actors, whose contribution to complex rug pulls is making early investors back off from projects with huge potential. Hence, when airdrop news covers another interesting project, users have to do thorough research on the team’s background and tokenomics, and be wary of the hype surrounding the project to avoid worthless tokens in their portfolio when liquidity vanishes.
However, airdrops are efficient in rewarding early adopters of crypto projects. They offer free exposure to new assets, create potential for future gains, and contribute to community building. So, if you’re interested in investing in airdrops but are not sure how to avoid scams, here’s how to recognize the most common risk: a rug pull.
Understanding how a rug pull happens
Rug pulls happen when malicious actors suddenly abandon a crypto project after acquiring all the invested capital. This leaves users with unusable digital tokens. This is possible because they take the time to create a seemingly trustworthy project with a coin that appears to have significant future potential. The project is well-marketed, but the team might be verifiable in a few cases, which could confuse users. There are two popular types of rug pulls.
Hard rug pulls are the easiest to orchestrate
Hard rug pulls are the ones we’ve seen most often, where the team behind the project runs away with all the finances. It can happen once the token has reached a certain level of popularity and funds, at which point the team will exit the project through a malicious backdoor built into it. A clear indicator is when all channels of communication are deleted, which is rapidly followed by a sudden drop in the coin’s price.
In hard rug pulls, liquidity is stolen through a strategy in which the project’s founders list the coin in a pair with a popular cryptocurrency, then hype the project and attract investment into the liquidity pool. But there’s also the case where the actors code the limitation on a user’s ability to sell the coin, thereby locking people into the project until they dump it.
Soft rug pulls are gradual and more complex
Soft rug pulls might not generate the same marketing and social media noise, but are subtler and harder to counteract. In this case, the scammers will get rid of their tokens while still maintaining the appearance to their community, showing they are invested in its continuity, so no one gets suspicious. Then, they will gradually dump the entire project, which will confuse users as they were anticipating better returns and developments.
This type of rug pull is more sophisticated, as the slow fade of the fraudsters offers them a plausible way out, allowing them to cite factors like market forces or technical challenges that they claim interfered with the project’s continuity, making it difficult to prove their intentions.
Analyzing the signs of a rug pull
While it may become harder to spot rug pulls, it’s best to know the obvious signs of such scams. The first is unlocked liquidity, which allows owners to withdraw assets from the liquidity pool. On the other hand, locked liquidity prevents this from happening.
Rug pulls also tend to have an irregular token distribution, with a significant portion of tokens held by a small number of wallets, which makes it easier for scammers to dump them and contributes to price manipulation. Conversely, a distributed token provides protection against short-term price manipulation by large holders.
A rug pull will also operate without audits, which shows no interest in protecting the project or its users. Reputable crypto projects prioritize smart contract audits to identify and manage bugs. However, no audits can prevent exploitation of the project by team members or malicious external actors.
Another sign of a rug pull includes unusual spikes in token value. While it is true that cryptocurrency is volatile, prices that rise and fall within a few hours can be a tell-tale sign of a pump-and-dump scheme, especially when it’s not linked to events like new partnerships or listings.
Finally, an anonymous team behind the project is a red flag. This can either mean the creator has had previous problematic launches or that it’s deliberately planning a rug pull. A genuine crypto project is backed by trustworthy individuals.
Avoiding rug pulls in three steps
Avoiding rug pulls is important to maintaining morale when investing in new projects. That’s why it’s best to review smart contracts and token details to ensure the audit findings reflect a transparent, secure process behind the scenes.
The project’s online presence is as important in analyzing its level of trust. Genuine projects will be present on social media platforms like Telegram or Discord, where they have built active communities that participate in discussions and help sustain the project.
Last but not least, make sure you’re not investing out of FOMO (fear of missing out) or on the basis of unrealistic promises. Many founders have promised investors unimaginable rewards, but this is not possible. Unfortunately, the pressure to invest quickly and make money can lead people to make decisions without considering the logical aspects of an arrangement.
Final considerations
Rug pulls are getting more sophisticated and trick numerous users into investing in newly created coins. Once the asset’s value reaches a certain level, the founders will withdraw all funds and disappear, leaving the remaining tokens unusable. That’s why it’s best to watch out for red flags of a project, including anonymous teams, no social media presence, and rapid price swings. Being wary of FOMO and investing only after doing thorough research on the project is ideal.