Decentralized Finance, or DeFi, refers to Peer-to-peer (P2P) financial instruments created on top of a blockchain system (most DeFi coins use the Ethereum blockchain network) that don’t rely on central intermediaries (Banks and other financial facilitators). According to Coingecko, the DeFi space will be worth more than $100 billion in 2021. The influx of money combined with lack of legal governance, risk management, and compliance has made DeFi space a popular target for gamblers and fraudsters. The ‘Zero-sum game’ nature of these transactions means someone must lose money in order for someone else to profit. Often people get caught to rug pulls and end up funneling lot of money to small group of insider traders. In this article we examine how exit scams are performed, as well as how a vigilant investor may track and investigate such behavior in the crypto space.
According to CipherTrace, DeFi rug pulls, and exit schemes likely accounted for 99 percent of all crypto frauds in 2020. DeFi-related hacks now account for over 60 percent of overall hack and theft volume in 2021, up from only 25 percent in 2020. Many recent investigations have also been related to the usage of DeFi smart contracts to conceal and later for laundering of the funds.
There can be many types of new attractive altcoins in the market. First, we get interested and research them, keep an eye on them for sometime, and suddenly, they are nowhere to be found. The above situation is the nature of the crypto market. Lots of these cryptos end up being rug-pulls. Therefore, it is very important to do your own research to figure out whether it is a good project for you to invest in and if there is any danger of losing your money.
In this article we cover 5 ways to identify if an altcoin project is legit, what are the red flags of a shitcoin, or in other words we give you some tips on how to identify pump and dumps, also known as ‘rug pulls’ in the altcoin space. Even though these methods described here can be used to identify a rug pull, we cannot 100 percent guarantee the genuineness of an altcoin and its potential to be a shitcoin. Sometimes you will never know until it gets rug pulled.
What Is A ‘Rug Pull’ In Crypto?
Basically, a rug pull is a type of exit fraud/scam in which crypto developers and promoters quit a crypto project and flee with investors’ funds by selling their positions/holdings in coordinated fashion draining the Decentralized Exchanges’ (DEX) liquidity pool pertaining to that coin.
If you ever see a crypto price graph that looks where it’s at a certain price point and suddenly there’s a massive drop in prices out of nowhere, that is most probably a rug pull. The developers may have abandoned their project, selling everything they have and disappeared, causing the altcoin price to crash down. As said before, identifying a rug pull is very difficult nowadays. Scammers are turning out to be more intelligent day by day and know many ways to manipulate you and the market. In the recent past, social media influencers have been one of the most prevalent traps used to lure you out.
Rug-pulls are common in the DeFi ecosystem, particularly on decentralized exchanges (DEXs) like Uniswap and Pancakeswap, where fraudulent token issuers may generate, advertise tokens publicly and collect money without being audited.
Unlike centralized exchanges (CEX), decentralized exchanges (DEX) have less rules, regulations so they are like outlaw wild west for gamblers and speculators – People who are looking to make quick profit and move on to the next opportunity. We can call this a form of day trading. Obviously this investor group is very susceptible for getting scammed. There is no legal remedy since its almost impossible to track who’s the real perpetrator. Everyone understand its all part of the ‘game’. DEX are a complete red zone for beginner crypto investors.
One of the main problems here is that it is not a very complicated procedure to make tokens; anyone without any expertise can now make a token. Even on platforms like fiverr.com, there are people you can pay to make tokens for you for a meager price. You can pay someone like that to generate a token for you, then create a website and next get some social media attention, and boom, now you can have a legitimate project.
Actions of these scammers affect the reputation of whole Crypto industry. Nowadays general public does not easily accept new NFTs or altcoins because of high number of rug pulls in this space. Usually, more than a hundred altcoins are coming out every week, so it is very hard to recognize motivation behind creation of these altcoins. Even though an audit will verify the authenticity of an altcoin, it takes a week or multiple weeks to conduct an audit. As the developers want to unveil their product as quickly as possible, usually audits are not done that often.
Now that you know what a rug pull is let’s now examine 5 ways to identify such scam
1. Low or No Team Credibility
Before choosing a cryptocurrency to invest in, you should verify the developer team’s credibility by investigating the their track record, employment history, social media, industry connections, etc. When you are looking at a new altcoin, and you do not see any info on their project, or who the creators are, that should be judged as a red flag as there is no point in hiding the founders’ identity if they don’t have ill intentions.
Developers just need to publish their basic information, like who they are, brief details about their history. Any altcoin that does not have a face or person behind it can be considered sketchy might be a potential rug-pull, and you should avoid them.
2. Ambiguous Cryptocurrency White Paper
Whitepapers in cryptocurrencies explain the technology and purpose behind an altcoin project. Whitepapers include the summary, mission, tokenomics, diagrams, statistics, and other information to persuade potential investors to acquire the relevant cryptocurrency.
If the white paper is prepared in an imprecise and vague manner, it is typically a red flag that the company is planning for an exit scam. When you further inquire about the details of the cryptocurrency project, developers may give out very generic word salad answers to your questions. Having an external audit done is really important. You can get an independent 3rd party cryptocurrency auditor, a person who is specializes in Cryptocurrency and Blockchain forensics, to assess the project you are considering. Companies that already do external audits make the cryptocurrency ecosystem safe for all. Never invest in a crypto project that hasn’t undergone an external audit!
Being clear and specific on a whitepaper shows that they are transparent on what they are doing, how they are dealing with the tokens, how much the holders are keeping, how much they have spent, how much they are giving for the marketing, etc… Even with all the above information mentioned in the whitepaper, it could still be a fake crypto project. But if you see a project with unclear or confusing info on the whitepaper, you ought to be alarmed. You don’t have to understand everything on the whitepaper, but it should generally make sense. You will be able to get that sense if you thoroughly examine a few whitepapers of legit crypto projects like Solana (SOL), Uniswap (UNI), and Chainlink (LINK).
3. Unrealistic Projection of Returns
Unrealistic, over the moon promises of return is fairly prevalent way to mislead people not only in DeFi rug pulls but in all kind of frauds in general. To simply put, “If it’s too good to be true, then it probably is”.
Developers will be saying things like, “we are surely going to make you a millionaire in 3 months,” or “we will give you back 100x, 1000x”. Sure, it’s good to have such expectations, but if the developers themselves say something like this, please be careful. Marketing spin is one thing, but if they say they will multiply your funds in a very short time, find it as a red flag.
They might even say, “we have celebrities who have invested, we are experts, we have been doing this for a long time, etc.” Not only they will come up with unbelievable stories on returns on investment, but also sometimes they will bluff about unbelievable stories on how they will release an NFT marketplace, they are going to list the coin on Coinbase and Binance very soon, how they will release an app very soon, or how they are going to build a website, etc. When you hear this kind of stories, you must always do a background research on how capable of founders to deliver on these promises. If they have a crew of like 10 to 20 people and some recognizable company/fund behind them, those stories can be realistic.
The main goal of these rug-pullers and scammers is to get as many people to enroll in their projects early as possible, so the market cap goes up, and when the target is reached they will pull the rug. It is hard to spot these things, but doing your research and exposure to the space will make it straightforward for you to determine a rug pull from far.
4. Significant Spending on Promotion and Marketing
Although hugely publicized ICOs are not always a fraud, take care when opting to invest in companies that are highly advertised or promoted. This is because less trustworthy founders rely on marketing and advertising to draw investors. You should always do due diligence before investing in a heavily promoted project.
You should check if the token/coin creators have published a whitepaper, if it has good tokenomics, have done external audits, and if the company is listed on any of the major cryptocurrency exchanges or if they are trying to hide those stuff with huge marketing, using giant billboards everywhere, using influencers (Tiktokers, YouTubers) and celebrity hype mans.
If they haven’t done these before going public or allow others access to these critical due diligence work and instead have spent a tremendous amount on marketing, then they are surely trying to fool you.
5. Few Wallet Holders and Listing only on decentralized exchanges (DEX)
Block explorer tools like Etherscan (a tool to help you view data regarding any pending or confirmed Ethereum blockchain transactions) or BscScan on the Binance Smart Chain, can confirm the number of holders of a particular altcoin/token. Check and see if the altcoin is listed and traded on other well-known exchanges. More information on the coin may be found by conducting a brief search on Coingecko.
Obviously, there is high transparency for cryptocurrency transactions since they are recorded on a public ledger (blockchain). You can always check how much funds are allocated for a coin/token at the moment, and if there is a specific wallet that has like 60-70% of all the tokens, that should be considered as a huge red flag for a rug-pull, as there is no purpose for one wallet to hold that much of tokens.
Examples of famous Crypto Exit scams and Rug Pulls happened over the years
The USD value locked in DeFi has increased dramatically in 2020, raising money laundering concerns since compromised DeFi protocols account for the bulk of crypto-related crimes. According to CoinGecko, to the latter part of 2020, DeFi has locked in $19.8 billion – 23% of Ethereum’s entire market capitalization – a more than 1000% rise from $1.7 billion at the start of 2020. The figure has already risen to more than $130 billion by the 2nd quarter of 2021, demonstrating the tremendous expansion of the DeFi space. The influx of cash has attracted plenty of scammers and hackers, as seen by the growth of DeFi rug pulls and exit scams.
Thodex, a Turkish crypto exchange with over 400,000 customers, was accused of executing an exit fraud earlier this year (2021). According to Thodex’s website, the program is “temporarily out of service” due to “an abnormal fluctuation in the company accounts”. The exchange had many customers, and its CEO reportedly fled Turkey with 2.2 billion dollars in funds from the unfortunate victims.
2. Compounder Finance
Compounder Finance did a rug pull earlier in 2021, with $10.8 million in investor money taken. Compounder Finance’s contracts were emptied of $750,000 in wrapped Bitcoin, $4.8 million in ether, $5 million in dai, and a minor amount of other types of tokens. While they had previously been audited, the team exchanged the secure and audited contracts with malevolent contracts that allowed them to loot people’s money.
3. Meerkat Finance
Another case in point is Meerkat Finance, a DeFi project that was emptied of $31 million in assets. The firm stated on its official Telegram channel that its smart contract vault was hacked.
These are genuine instances involving millions or billions of dollars in losses and a massive number of victims. With the increase of DeFi frauds and exit scams, we require quick and dependable methods of detecting and investigating such frauds.
Let’s check this real life Rug Pull to understand how the scam works in practice
To learn more about how a rug pull process is conducted out on a DeFi network, we can examine the TRUAMPL token, a currency that is similar to Ampleforth (AMPL). The coin was recently created a buzz on Twitter and also got highlighted on a post titled ‘The Dark Side of DeFi’.
There were several fake TruAmpl tokens produced to initiate the pump and dump process. Looking at the transfers log with Etherscan, we can see that there are only 20 transactions and 10 holders. All the action occurred within 4 day duration. At the start (2020-08-15) scammers with wallet ID 0x5d64a2b59328c1e387806ebefaebcf57a45a298e added some Ethereum liquidity toward the freshly hyped-up token. This wallet holds the majority of tokens. On the same day we can see serval Buy offers that pumped up the token little more – Other investors/gamblers have seen the opportunity and may have jumped on board due to fear of missing out (FOMO). Social media buzz could be another reason for buy side pressure. After the target price is reached the scammers (0x5d64a2b59328c1e387806ebefaebcf57a45a298e) have removed liquidity from the token essentially pulling an exit. Other participants/gamblers are left with useless tokens and no way to cash or withdraw them out.
A full analysis of how fraudsters executed this scam is available HERE.
While the case above show how scammers use DeFi platforms to trade fake tokens, similar tactics are used to conceal illegitimate sources of funding. By switching to less popular tokens (perhaps even ones produced by scammers), these parties hope to avoid efforts by cryptocurrency monitoring systems to follow the origins of their illegitimate earnings. Investigations also indicate how alleged money launderers exchange illiquid assets in DeFi platforms to hide the origins of their cash.
Even in established and well-regulated financial markets, frauds are prevalent. The unregulated structure of the crypto market, along with the influx of cash in the DeFi space, heightens the danger of such rug pulls and exit scams. With thousands of investors and millions and billions of dollars at stake, an effective surveillance solution and a legal framework is needed to combat the growing danger of cryptocurrency fraud.
PSS: This article is inspired from a cylynx.io publication. You can view the original post from HERE.