Headline: Rug pulls are dangerous.

Date: 4/28/2022

Body:  In studying the stock market, people run into “chart patterns” and each pattern has an endearing name.  (I think there’s the iron butterfly, the pennant and several others.)   These are indeed evocative, but, do they have anything to do with cryptocurrency?    Hard to say for sure, but there are some evocative names for scams within the cryptocurrency ecosystem, and I’d like to say a few things about “rug pulling.”  Hundreds of hours of my childhood were mis-spent watching cartoons, and without exception, when one character would pull a rug from beneath another, hilarity would ensue.  It’s not quite so funny when it’s your personal fortune and future on the line.

Outside of a Tom & Jerry cartoon, what is a “rug pull”?

Rug pull is a reference to how suddenly the currency loses value.   In such a scam, usually just after a very successful ICO, the founders disappear with millions of dollars.   The rumors spread, and the value of the cryptocurrency they were touting goes down precipitously.  This particular scheme is quite popular and was responsible for losses of $2.8 Billion last year alone.  Usually these happen on the very open DEX (de-centralized exchanges) because there are no code audits.  Code audits are very important because each of the smart contracts (remember, really, just pieces of code) are inspected for backdoors that can make it easy for unethical promoters to steal money quickly.  (As I am doing my research for this piece, I have found dozens of examples of rug pulls on DEX exchanges and only one on a centralized exchange.)

Are there flavors of cryptocurrency scams?

Generally speaking, cryptocurrency scams fall into two different categories:

  1. Initiatives aiming to obtain access to a target’s digital wallet or authentication credentials. This means scammers try to get information that gives them access to a digital wallet or other types of private information such as security codes. In some cases, this even includes access to physical hardware. 
  2. Transferring cryptocurrency directly to a scammer due to impersonation, fraudulent investment or business opportunities, or other malicious means.  This includes social engineering of all types, and imposters who claim to be somebody they’re not.
  3. With the rise of new crypto-based investments such as initial coin offerings (ICOs) and non-fungible tokens (NFTs), there are now even more avenues for scammers to try to gain access to your money. The background of these investments is beyond the scope of this article, but what’s important to know is that although crypto-based investments or business opportunities may sound lucrative, this doesn’t always reflect reality. For example, some scammers create fake websites for ICOs and instruct users to deposit cryptocurrency into a compromised wallet. In other instances, the ICO itself may be at fault. Founders could distribute tokens that are unregulated by U.S. securities laws or mislead investors about their products through false advertising.
  4. DeFi rug pulls are the latest type of scam to hit the cryptocurrency markets. Decentralized finance, or DeFi, aims to decentralize finance by removing gatekeepers for financial transactions. In recent times, it has become a magnet for innovation in the crypto ecosystem. However, the development of DeFi platforms is beset with its own problems. Bad actors have made away with investor funds via such avenues. This practice, known as a rug pull, has become especially prevalent as DeFi protocols have become popular with crypto investors interested in magnifying returns by hunting down yield-bearing crypto instruments.

I’m not a coder.   How do I avoid these?

  1.   Check for low liquidity.   If it is very difficult to transfer into another cryptocurrency or into cash, that might be a signal to not invest in that particular currency.  Be sure to check the 24-hour trading volume to see if it has liquidity issues or not.
  2. Do background checks.   Download the whitepaper associated with the currency, and really understand how it works.     Identify how you can change back into cash.   Identify the management team and understand how solid they are.  If the management team is not identified, perhaps you should take this as a sign not to invest.  Remember, the core team within management should be using their real names.  If some minor officials within management appear to be using pseudonyms, this could be OK.
  3. If it is a valid cryptocurrency(and not a scam) the developers will “lock” their control of the liquidity pool, and make it impossible for them to gain control of the financial assets.   They do this by “burning” the private key they used to start the liquidity pool.   So, as you read the whitepaper (you DID read the whitepaper, right?) look for a policy to burn their private key to the liquidity pool.
  4. As you read the whitepaper, you should not see dozens of grammar and spelling mistakes.   If you do, this is probably a bad sign.

Are there some current examples?

In November 2021, a cryptocurrency token associated with the hit Netflix series went from $2,586 to a penny. The project promised that an anti-dumping mechanism was written into the code, making the $SQUID token immune to a flash-crash. Supposedly, token-holders could only sell by also holding the $MARBLE token. Yet, the anonymous founders made off with approximately $3.3 million with virtually no consequences.  

Filed under the hashtag, “ironic” there was a project called “Waronrugs” and there was a DEX campaign to raise money to look carefully at some of these projects.  As soon as the liquidity pool was $2 Million, the developers skipped town with all of the money.  (Kind of like The Producers, huh??)

Who is supposed to regulate these markets?

Well, nobody really.    Let me explain.   Some of the frauds are investigated by the DOJ after receiving a heads-up from the IRS.  The FTC writes information about cryptocurrency in a variety of publications.    The CFPB is also involved.   To be blunt, it’s really alphabet soup run amuck right now.  There is little organization, cooperation is, well…  Everybody CAN find a way to get involved, so nobody is held accountable.  (I keep seeing references to the “Wild West” but this seems simplistic.)  Whatever agency comes to regulate cryptocurrency, they will have their hands very full, as the novelty will bring numerous scammers, jammers and spammers.

The Verdict

Still ringing in my ears are the words from my Dad.  “If it seems too good to be true, it probably is.”  Multiple articles point this out in various ways, but, it all comes out to the same thing.     If you see the word “guarantee” run away.   If you see a term within the whitepaper that you are unsure of, please consider investing elsewhere.  If you can’t understand the purpose of the ICO, consider not investing with them.  If you can’t see the possibility of selling an NFT, consider not buying it.  Cryptocurrency can be exciting, but it shouldn’t include a near-death-experience with that excitement.







Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

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