Launched in October last year, the new cryptocurrency token inspired by the popular South Korean Netflix series skyrocketed in value as investors rode on the hype to relate themselves to the tv series. The developers of $SQUID promised a project where it would replicate the tv series with a play-to-earn game that would require an amount of Squid tokens in order to participate.The Squid tokens then went on to increase at an astonishing rate on 1st November, and rose by more than 35,000% in just three days of trading on PancakeSwap. Unsurprisingly, SQUID quickly crashed and plummeted to nearly zero, while its unknown developers made off with approximately $3.3 million in funds.
What is a rug pull and how it is conducted
This manoeuvre, also known as a rug pull, occurs when developers of a token or coin abandon the project and run away with the investors’ funds, leaving their investors with valueless digital assets. Rug pulls are exploits in the DeFi system, and typically occur on decentralised exchanges (DEXs) where fraudulent creators are able to create and list tokens for free without audit. There are three main ways that a rug pull can happen:
- By stealing liquidity where token creators withdraw all the coins in the liquidity pool, and investors are left with coins that no longer hold any value.
- The developers sell significant portions of their own tokens, often referred to as dumping. After pumping their tokens by convincing and selling their project to hype their investors, developers then dump their tokens for profit, and the price of the coin is drastically decreased.
- Removing the ability to sell the tokens. Some token creators can add codes to their token such that investors are not allowed to sell their tokens back to the DEXs, but only the developers themselves. In this way, the price of the token will only go up because nobody else can sell their token even if they wanted to. When the price of their token is really high, the fraudulent developers then dump all their tokens to reap profits.
Common signs and red flags of rug pulls
- When the liquidity is not locked
- Sometimes to prove that they are a legitimate project, many developers will lock up their liquidity with a trusted third party to ensure that they can’t pull out that liquidity even if they wanted to. This is a very good sign that the project will not get rug pulled. If the liquidity pool is left unlocked, developers can potentially withdraw and run away with the valuable cryptocurrency from the pool. It is also important to pay attention to how long that liquidity gets locked up as some projects will do it for only a few months, while others for a much longer period of time.
- Limits on sell orders
- After the launch of the Squid token, the community was alarmed and reported that users were unable to redeem their proceeds or sell their tokens. As mentioned earlier, developers can rug pull by removing the ability to sell the tokens, hence, it is necessary to look out for this before investing.
- When a few wallets have a large percentage of all the coins
- It is highly likely that developers bought a significant portion of the coins during the initial launch. Even if this did not happen, dumping by other whale wallets could also greatly crash the price of the coins. These whale wallets can easily manipulate the price of the coins.
- No audits done by external trusted sources
- Notable cryptocurrency projects undergo formal code audit processes conducted by a reputable third party to vouch for their authenticity. It is crucial for investors to not simply take the developers’ words that an audit has taken place, but to research thoroughly that there are verifiable audits by third parties.
- Minimal effort websites/white papers, little to no social media presence
- It takes a lot more time to create distinguished websites and establish social media presence, while fraudulent developers often have low-effort websites that are created or copied quickly in just a short amount of time and also low engagement with the community. Furthermore, some scam projects have poor quality white papers that are copy-pasted. For instance, many were sceptical of Squid token as their white paper was known to be filled with spelling and grammatical errors.
What should investors look out for?
The case of Squid token scam and many other rug pull schemes demonstrated how sophisticated and carefully orchestrated digital frauds can now be. Unlike traditional bank accounts for regulated currency, there is no such thing as broad protection on the blockchain. On a decentralised exchange, it is also highly unlikely that investors will recoup any stolen currencies. Hence, it is imperative for investors to do their due diligence and take their time to research on the new and rising cryptocurrencies before making the decision to invest in new projects.