A rug pull is a type of exit scam that occurs in the decentralized finance (DeFi) space. It involves the creators of a DeFi project suddenly and unexpectedly withdrawing all of the funds from the project's smart contract and disappearing, "pulling the rug" out from under their investors. This can result in significant losses for the investors, as they may be left holding assets that have become worthless.
The firm Chainanalysis said in 2021, there was $2.8 billion in rug pull stolen by scammers, or $7 million per day.
There are three types of rug pulls that are common; liquidity stealing, sell order limiting and dumping.
Liquidity stealing occurs when a token is created and the creators withdraw all the coins from the liquidity pool. This removes all of the value investors have injected into the tokens and drives the price down to zero.
These types of liquidity pulls usually happen in a decentralized finance environment, which is the most common type of exit scam.
Sell Order Limiting
Limiting sell orders is a way for a token's developers to defraud investors by coding the tokens so only the the developers are allowed to sell them. An example of this type of scam was the Squid Token scam, which saw the token soar by 23 million percent before becoming worthless after the rug pull.
A coin called SQUID was launched on the Biance SmartChain in 2021 amid the popularity of an unrelated Netflix show called "Squid Game." Using the popularity of the show, which focused on cash-strapped adults playing children's games in order to win a cash prize and gain worldwide fame, the SQUID developers attracted $3.3 million from investors. Investors were attracted by a "play to earn" game where they could earn marbles needed to sell their SQUID.
After the price of SQID skyrocketed, the developer rug pulled the value and drained all the liquidity from the token. Reportedly, a Twitch streamer caught the rug pull on a live stream in real time while the coin's value dropped from $2.2 trillion to zero almost immediately.
The scam begins with the creation of a new cryptocurrency token listed on a decentralized exchange and paired with a coin from a leading platform, such as Ethereum. Using the powers of social media, fraudsters launch a buzz-filled promotional campaign across multiple channels to bait naive investors. The scams often involve "to good to be true" claims or involve a membership similar to a Ponzi scheme.
Once the token gets enough traction from investors, the token's value increases. And once the price of the token peaks, the Web3 development team dumps its share of the tokens and walks away from the project. This is akin to a typical "pump and dump" scheme.
The first rug pull was thought to be when the U.S. Department of Justice charged Frosties founders Ethan Nguyen (“Frostie”) and Andre Llacuna (“heyandre”) with conspiracy to commit fraud and conspiracy to commit money laundering.
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- Scams Explained: What Are Rug Pulls? Are They a Crime?. NFTNow.com.