5 Tips to Identify Rug-Pull Projects
Artwork by Milad Fakurian
At face value, investing in NFTs and cryptocurrencies seems relatively straightforward. You find a project you like, head over to an exchange you trust and change your FIAT currency to the correct crypto in order to invest in said project. Unfortunately, it is not always this easy. In fact, investing can sometimes even be dangerous for your portfolio, if you end up investing in rug-pulls. What is a ‘rug-pull’ you may wonder?
Well, the visualization represented when someone literally ‘pulls the rug from under your feet’ is very much indicative of what a rug-pull is. It is a crypto-related scam in which the developers of a digital token or (IOU) NFT project disappear with the entirety of the invested funds. This is usually also done before anything of value is released to the tricked investors, which has deemed this phenomenon to be a horrible by-product of the crypto industry.
This article will go through the rug-pull process on the XRPL & help you identify common red flags you should look out for when investing in new projects or tokens.
What Are The Most Common Rug-pulls on The XRPL?
Currently, fully minted NFTs are not available on the XRPL. The XLS-20d is unfortunately still an unadopted protocol and as such, XRPL-native NFT projects have adopted the tokenization of their series using IOUs. Although this approach invites innovation and creativity to occur on the XRPL, the insubstantial nature of the IOU format is subject to a higher degree of fraud, compared to their minted NFT counterparts. Projects can release a roadmap, designs, and even a fully-fledged Whitepaper but until the NFTs are minted, the IOU remains a token worth what the market has deemed it to be worth. No more, no less. So, how do you sift out the junk?
In this case, long-standing projects are usually more trustworthy, as their price is indicative of market conditions over longer time horizons (supply and demand). This means that investors are and have been willing to trade the IOU for relatively longer periods. The same rhetoric can be applied to younger projects, but the other way around. Due to their novelty, the price is nowhere near indicative of their competence, as it remains to be tested by market fluctuations and investor scrutiny. Although they can be more lucrative, they can also be more prone to rug-pulls due to their lower market caps. But when could a rug-pull occur?
Rug-pulls could occur at any time during the development phase. For instance, after the initial release of an IOU token through an ICO, in which, the project’s team could take all the invested funds without having to provide anything after the sale. It could also occur later, after the project has been established. A project could assimilate a community, issue an IOU token and create a beautiful NFT series just to decide to rug-pull at the last instant.
Although aspects such as having an airdrop after an ICO are integral to constructing a healthy community, they do not automatically mean the project is legitimate. In fact, con artists know exactly how to trick investors as they often follow the footsteps of authentic projects to emulate and exert similar behavior. This gives a sense of trust toward their newly built communities and allows them to deceive larger segments at a time. Another important thing to realize, is that community members can also take part in the scam. For example, someone screaming ‘paper hands’ in the Discord could very well be part of the scheme, and therefore, you should track how certain members behave over time to ensure the safety of the community and, subsequently, their funds.
Unfortunately, the current XRPL NFT structure leaves room for fraudulence. In order to help yourself, it is of utmost importance that you DYOR before investing large sums of money into projects. To help the community, you must always keep track of fraudulent activities and report them as soon as possible. Staying vigilant means staying with your head above water. For this, we all need to assist each other.
Depending on the De-Fi initiative, a token is usually created to provide liquidity to the project team. For DEX-focused projects, this is mostly done via an Initial DEX Offering or IDO. In an IDO, investors are offered the token during a limited period of time at a set price, much as they would during an ICO. The proceeds are then given to the project’s team which may decide to lock up the earnings or use them for other activities.
Once the project has reached high levels of traction and access has been given to the locked liquidity, the rug pullers often have two options:
- Option 1 → Sell their large share of tokens at a high price and remove all the liquidity.
- Option 2 → Use backdoor/bugs in smart contracts to steal all IDO investor funds.
In situations like these, asking yourself a few questions could save you a great deal of pain in the future. For instance, how large is the founders’ reserve, or does the team intend to release the ‘founders’ reserve’ gradually/linearly, or do the disclosed tokenomics make sense in comparison to the visible liquidity on the DEX? For instance, if after an IDO, a significant influx of liquidity appears on the SELL side, this could be an indication that the team has begun to sell off part of their tokens. If massive sell-walls appear on a regular basis and the liquidity has run dry, this could also be a tell-tale sign of fraudulent activity.
That being said, nothing is set in stone. Everything should be taken with a grain of salt and investments should only ever be placed once you have conducted a comprehensive risk assessment of the situation.
How to Try and Avoid a Rug-pull?
Tip 1 – Research the Team
It is crucial to research the team behind the project you are investing in. A typical red flag is the anonymity of the developers and the team. If there is no information on who they are or what they do, you should stay away from such a project to minimize risk exposure. Furthermore, you should thoroughly research their experience within the industry. If none has any industry experience, you may want to back away from the project or simply wait a little before investing. Testing the waters when others have done so is still a viable investment mechanism.
Checking the social media handles of projects is essential when identifying rug projects. The most prominent social media channels in the crypto sphere are Twitter, Discord, and Telegram.
On the Discord and Telegram chats, you should be looking for the authenticity and volume of chatter. Are people communicating with each other or are they just people spamming with no interest in what the project is about. You should also see if people are getting banned or muted for asking difficult questions or bringing up specific topics revolving around the legitimacy of a project. If this is the case, once again, you should be alerted.
On Twitter, you should be looking at the activity on the page in order to determine whether this is real or not. Social media is full of bots and accounts that buy thousands of followers at incredibly cheap rates. Furthermore, the availability of information on their accounts could also be an indication of fraudulent activity. If there is limited information, no website, or no article explaining the project, you might have to stay away.
Tip 3 – Check project distribution
Identifying the distribution of tokens or (IOU) NFTs is essential when investing in a project. A large majority of the distribution concentrated between a few wallets/people is a red flag. This is because whales, or developers, could dump their token or NFT project causing the value to crash. Thankfully, blockchains such as the XRPL are completely public and therefore, a few wallet addresses can get you very far.
Tip 4 – Has the project been Audited?
Checking if a reliable third party has audited the project is always a good idea. The only issue with this tip is that this is an expensive process, even for existing legitimate projects. Nevertheless, you can use independent auditing websites to check whether a project is a scam, has bugs, or is easily hacked. Auditing websites include Token Sniffer and Rug Doc.
Tip 5 – Surging Prices
If the prices of a token are very volatile or skyrocketing over a short period, you should be wary. If the token is experiencing an increase of 50x or more within a day, then you may want to consider whether to invest your money. This swift upward momentum can often be met with a reciprocal drop of equal proportions which could be detrimental to your wallet.
Although the crypto sphere is a new and exciting space, it can be daunting for impulsive investors that don’t like to spend time researching projects. However, it is essential to mention that identifying a rug project isn’t as simple as these five tips above and that you must do your research (DYR) to avoid falling into the trap. Scammers are constantly coming up with new and creative ways to trick individuals, so please be careful!