Of that, more than $2.8 billion was lost to “rug pulls” or “pump and dump” schemes, which account for the lion’s share of all illicit money taken from the crypto market by bad actors and developers.
Rug pulls occur when a token creator artificially inflates the price of a cryptocurrency token, abandons the project, and then flees with investors’ money.
They are characterized by a disproportionate increase in the token price.
Pump-and-dump schemes accounted for just 1% of all cryptocurrency scams by value in 2020, but by 2021 they had grown to around 36%, indicating a significant problem for crypto investors around the world.
What method of operation does a pump-and-dump crypto scheme use?
Crypto tokens serve as a medium of exchange for blockchain initiatives with specialized use cases such as decentralized finance (DeFi), gaming, media and entertainment.
These tokens are created in certain situations, e.g. B. when validators on the underlying blockchain participate in the consensus process, in accordance with a preset delivery mechanism.
Token developers occasionally build vulnerabilities into their programming that allow them to steal funds without investors’ knowledge.
These so-called “hard rug pulls” cause the creators of the project to flee with the funds received for further project development and are typically carried out during the first token sale period or immediately afterwards.
Soft rug pulls, on the other hand, occur when developers dump tokens on cryptocurrency exchanges, pushing the token’s price down.
While not technically illegal, soft rug pulls are typically much easier to spot than hard rug pulls, as they make it clear that the project’s developers had ulterior motives.
When the developers of the SnowDogDAO project decided to conduct a buyback, they switched to a special market-making platform called SnowDog AMM and sold the native SDOG token before most investors could even react to the sharp price drop.
A pump-and-dump scam is much more likely when investors rush to buy the underlying token without considering the project’s fundamentals, so investors should be wary of initiatives that make big claims.
Types of carpet pull
There are three main types of pump-and-dump schemes: dumping, restricting sell orders, and outright liquidity stealing.
With all pump-and-dump schemes, investors either have no tokens or a token that has been significantly devalued.
Dumping, a tactic in which the token developers themselves sell all their token holdings at the peak of investor demand, is more likely to occur on projects that have quickly garnered significant investor interest.
Investors can identify these initiatives by an excessive amount of social media promotion or additional prizes that might seem overly generous.
Similarly, liquidity snatching has become the primary method of stealthily removing investor funds from DeFi projects that have locked up a lot of value in liquidity pools where investors stake their tokens in hopes of earning returns on their investments that beat the market .
Because these funds are tied directly to the value of the token, the liquidity withdrawal has a cascading effect on the token’s price, eventually driving it to zero when investors wish to sell or withdraw their tokens.
According to Sharat Chandra, VP of Research and Strategy EarthID is a much more advanced type when developers limit the number of tokens that token holders can sell or the rate at which they can sell them.
Such tokens can increase to remarkable amounts in a short period of time as investors are restricted in their ability to sell their holdings, which is typically introduced as an anti-dumping feature.
This creates a notional supply-demand gap that gives creators the advantage of being able to sell tokens at any time.
“Last November’s launch of the Squid Game token was a great example of this type of carpet pulling, with the SQUID token surging to over $3,000 just days after launch. However, due to an anti-dumping mechanism built into the token, investors could not sell any of the purchased tokens. As a result, at the height of the excitement, the creators of the project sold all of their token holdings and appeared to have walked away with nothing wrong,” says Chandra.
Avoiding such schemes
Raj A Kapoor, Founder and CEO of the India Blockchain Alliance says that while investors can’t do much once they’ve invested in a token that’s the target of a pump-and-dump scam, there are warning indicators they can do must be conscious in order not to become a victim in the first place.
“Some tell-tale symptoms of a fraudulent cryptocurrency project are guarantees of notable profits, projects created by unidentified parties, restrictions on sell orders, and one-way price movements,” says Kapoor.
Another indicator of an impending rug pull that can be easily spotted by investors studying the token’s whitepaper are elements like weak or no liquidity blocked by the project creators.
More sophisticated techniques such as B. changing the code of the token to the benefit of the developer, however, can be difficult to detect for less experienced investors and can only be prevented by examining the previous experience of the developer.
The best way for cryptocurrency investors to protect themselves from such pump-and-dump operations is to thoroughly research the project’s “tokenomics” and stay away from tokens issued by developers who have no prior track record or experience with have blockchain projects.
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