“If you don’t understand the pros and cons of the crypto project you have invested or intend to invest in, you may be surprised by market manipulation, smart contract errors or any black swan event and may end up losing your hard earned money. That’s why DYOR is always advisable: (Do Your Own Research: do your own research)”.
A recent ‘Rug Pull’ event in the crypto industry was the following.
The TITAN token price dropped to zero and the project claimed to have “experienced the world’s first massive run on crypto banks”. People kept cashing out and the token price kept falling. When people redeemed their initial collateral, they started selling in a race to the bottom. This created a domino effect as more and more players opted out of the game and TITAN prices fell severely within hours. Billionaire investor Mark Cuban also lost a lot of money, although he claims to have invested “only a small percentage” in the project.
This bank run issue is one of the relevant risks for all Defi investors to consider. So today I want to decode the Rug Pull for you in the hope that it will help you make more informed investment decisions in the future.
So let’s get started by understanding.
What is a Rug Pull?
The chart above shows this phenomenon in a simple and brutal way.
The crypto world houses multiple blockchain-based, DEFI, DEX, DApp, and smart contract projects that provide ordinary people with new tools to invest and grow. The dream of financial freedom has never been more within reach, and the crypto space has given humanity new hope, new power to exercise and change their destiny.
But with all of these enticing promises come unexpected risks that can even crush those dreams if you don’t take responsibility for the investments you make. There will always be “bad guys” with the selfish intention of making someone’s life miserable by getting rich quick, so they are not afraid to manipulate the highly unregulated cryptocurrency market for their own benefit.
Defi platforms are most vulnerable to such malicious intent, and being highly unregulated, they are vulnerable to such attacks. As a result, as a retail investor, you may risk losing all the money that is pledged or concentrated in these Defi projects, and such a risk is the rug pull.
Rug pull is a malicious manipulation in the cryptocurrency space where Defi project owners (developers) may abandon the project and run away with their investors’ money, with software fixes being the usual excuse they use.
Rug pulls are most common in the Defi ecosystem, and decentralized exchanges (DEXes) are the biggest victims. Many new Defi projects spring up with their own native tokens, which developers pair with popular tokens like ETH, USDT, DAI, etc. and allow users to swap them with the paired tokens to attract investors with higher returns. As the number of investors grows, they “run away” with the established ETH/DAI/USDC/USDT etc. pooled in the protocol.
Developers with malicious intent find it easy to create DeFi platform tokens because these platforms offer the freedom to do so without having to vet every token listed on their network, and such developers primarily use the ethereum blockchain because it is open source and has the ERC-20 standard to easily create tokens.
How to identify such projects and protect your money?
Check the liquidity pool of a given Defi project
An easy way to check the liquidity of a project-specific pool of funds is to check the liquidity of the project. A high level of liquidity is a sign of the strength of a DeFi project, but this does not solve all the problems and it is also important to check the project’s development history and the team behind it.
For example, UniSwap, Bancor, AAVE, Compound have been running for over 2-3 years and have enough total value locked into their Defi ecosystem that it is relatively safe to invest liquidity into these programs.
Always research founder history
Never blindly follow any news or rumors and plan to invest, or simply because pledging your tokens gets you a higher return. Always research in depth who the founders of the Defi projects you wish to invest in are. Who is backing those projects? Have there been any reports of past issues against them and more like that?
Check the token lock-up period against DeFi’s liquidity pool
Liquidity pools are the foundation behind any DeFi project and without sufficient liquidity they cannot provide the following trading features.
Automated Market Makers (AMM)
Crypto Mining / Liquidity Mining, etc.
All of the above services together power the DeFi engine, and they require sufficient liquidity in the relevant liquidity pool to run smoothly.
Therefore, make sure you understand how long the platform enforces a lock-up period for the tokens in the pool. The most reputable & trusted projects lock up liquidity for a period of time to protect the interests of their investors.
Sudden fluctuations – token price spikes
One thing that is speculative risk is a sudden spike in the price of a token in a given liquidity pool.
So if you notice a sudden 50x or 100x increase in the token price, you need to be cautious about this speculation as it could be a trap that triggers a so-called FOMO to attract more investment.
Beware of high rewards.
Newly launched DeFi pools may offer high rewards for your collateral tokens as they also want higher liquidity. But you need to be cautious when any program starts offering unexpected 500% or 1000% returns, which is not normal for established DeFi players.
That’s why there is a famous saying: “All that glitters is not gold”.
You should keep this in mind and be extra careful with your decision.
Some of the major ‘Rug Pull’ events from the DeFi space.
Messari Report: Defi hacks have caused over $284 million in losses since 2019, with the average amount stolen in a ‘Rug Pull’ incident being $11.9 million.
Thodex: In 2020, Turkish cryptocurrency exchange Thodex, which has around 400,000 users, was accused of running away and the Thodex website was shut down, with them declaring, “Temporary closure to address unusual fluctuations in the company’s accounts.” Thodex, the CEO, allegedly took $2 billion in customer funds and fled to Turkey.
Meerkat Finance: This DeFi project consumed $31 million worth of crypto assets. On its official Telegram channel, the team claimed that its smart contract vault was compromised.
Many of these incidents are being identified and reported, so given the increase in bank runs, ‘Rug Pulls’ and runaway scams, you need to be more responsible with your investment strategy, do your homework and avoid blindly investing in any new DeFi projects.
Malicious hackers often exploit people’s get-rich-quick mentality and FOMO instincts to trap investors, but if you are a level-headed and cautious investor, you will see a lot of problems, and after calculating the risks, you can sleep soundly with your money.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/fear-of-rug-pull-when-playing-defi-how-to-protect-your-money/
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