Rug pulls (also known as rugs) are scams that target users who invest in ERC-20 tokens or NFT collections. They trick people into sending crypto to the project, developers, and/or artists, who then fail to deliver on their promises, and disappear with the funds - pulling the rug out from under the people who supported them and believed in their idea. Rug pulls can be tricky to spot, since they often involve creating an attractive teaser, website, and initial marketing for an NFT collection. But it's important to DYOR (Do Your Own Research) on the artists and developers behind these projects. Look up their social media profiles, reviews, and other online interactions to determine if they are legitimate. That's the best way to avoid getting scammed by rug pulls - do your research and beware of projects that look like they are "pumping" i.e. being heavily promoted.
The anatomy of a rug pull
- Scammers create a token or NFT collection (the rug), often under a new account, or by buying a highly-followed account that is for sale, and converting it into a NFT / Crypto looking profile by setting a NFT profile pic and retweeting some crypto news.
- The scammers market and advertise the rug. This could include sending their rug to popular known collector wallets, hoping those collector's followers will think it's the next hot thing to be collected, and will FOMO in (buy in for fear of missing out).
- The scammers will inflate the price of the rug, often by wash-trading (buying and selling the rug for higher prices between themselves to make it look like it's performing well on the chart).
- They count on new money coming to hold the bag of their rug at the all-time-high, so they will try any trick in the book to attract new investors to the rug. Then, the scammers pull the rug, and sell a huge number of tokens or NFTs into the market, forcing the price down to nearly zero while taking all the funds in the buy column of the order book.
How to avoid rug pulls
Question the TDMU metrics: Time, Distribution, Marketing, Utility
Time - How long has the project had to mature? If it's less than a month, that's a red flag.
Distribution - Look up the project in blockchain explorer by searching the contract address, and check to see how many addresses are holding the token. If you see that only a few addresses are holding a majority of the token, that's a red flag.
Marketing - Check Twitter and search for the project name. Is it being promoted by a ton of shady looking accounts? If so, that's a red flag. Conversely, if it's nowhere on Twitter, and nobody is talking about it, that could also be a red flag. You want to find organic discussion when you search the project, then you can get a better idea if the project's hype is real or not.
Utility - What use does the token or NFT offer when you buy it? Is it named after a current event that will fade into obscurity in a few weeks? Can you use it in a game, metaverse, or is there any other benefit for holding?