How to protect yourself from ‘rug pull’ scams in new crypto projects

How to protect yourself from ‘rug pull’ scams in new crypto projects

The racket is an old investment scheme. Cryptos’ loose regulations for fundraising and their emphasis on decentralization, can make frauds hard to spot .

A new type of scam has emerged in the hype-filled world of cryptocurrency: the “rug pull.”

The scam, which gets its name from the expression “pulling the rug out,” involves a developer attracting investors to a new cryptocurrency project, then pulling out before the project is built, leaving investors with a worthless currency. It’s part of a long history of investment schemes.

“This isn’t a crypto-only phenomenon. This is a people phenomenon. Crypto is just the latest way to do it,” says Adam Blumberg, a Houston-based certified financial planner who specializes in digital assets. But cryptocurrencies have particular risks due to loose regulations for fundraising and their emphasis on decentralization.

Cryptocurrency projects often use “smart contracts,” agreements that are governed by computer software, not the legal system. This setup can be a benefit when it reduces transaction costs, but it also leaves little recourse if things don’t work out.

Rug pulls have been particularly common in decentralized finance, or DeFi, projects that aim to disrupt services such as banking and insurance. NFTs, or non-fungible tokens, that provide digital ownership of art and other content, have also been involved in rug pulls.

Investors can protect themselves by choosing established cryptocurrency projects, making sure the code of any new project has been reviewed and verifying the developers’ identities.

Pick established products

Rug pulls are most common with new projects that haven’t gotten the same scrutiny as more established cryptocurrencies.

Bitcoin has its risks, but countless people worldwide have used it and reviewed its inner workings, which are readily available online.

Newer projects don’t have such a track record, which means there may be vulnerabilities that make it possible for their organizers to siphon value away from investors and keep it for themselves.

If you’re struggling to break through the hype, one way to find established projects is to look at centralized exchanges such as Binance, Coinbase and FTX. While the presence of a cryptocurrency on a large exchange is by no means a guarantee of its quality or investment potential, these businesses often will review assets before listing them for sale.

The trade-off of investing primarily in more established assets: While cryptocurrency, in general, has seen periods of rapid price appreciation, the highest rewards may come from new projects where the risk is also higher. These are often listed on “decentralized exchanges,” which don’t rely on any centralized authority that would prevent unproven projects from joining.

Rex Hygate, founder of DeFiSafety, a company that reviews projects in the field, says scammers can prey on the fear of missing out that’s generated by rare but true stories of mind-blowing returns.

“It is seductive. People have made a lot of money. That is a fact,” Hygate says. “The hope is real, albeit small, [and] therefore criminal organizations in an organized and regular manner are making these rug pulls.”