We have all heard about that one person who invested in some shady, worthless coin in hopes of getting a five or ten X, only for his money to disappear overnight, and never wanting to trade ever again.

How exactly does that happen?

Well, the infamous rug pull happens anytime a developer of a certain token runs away with the coin investors’ funds. This can happen in basically three ways.

1. By "yanking" the liquidity pool

When developers create a token, they also need to set up a way in which investors can actually buy it.

The standard method is setting up a liquidity pool containing portion of valuable tokens and a portion of their newly minted tokens.

By having this token pair in the liquidity pool, investors can thus trade their tokens for the new ones.

As time goes by and investors buy the new token, the imbalance in the liquidity pool causes it to be higher priced.

When that happens, developers can pull out their initial liquidity and thus get back the initial amount of the token which they have created as well as the valuable token they have originally put in.

Consequently, due to how liquidity pools work, they will be getting a lot more of the valuable token after they yank out the liquidity.

Moreover, other investors will not be allowed to trade because there is simply nothing else in the liquidity pool.

2. By developers selling their shares

Anyone can create a worthless token. Tokens derive value from whatever its project aims to accomplish or from other people thinking it has value due to its potential or other surrounding factors.

As usual, developers will try to convince the public that they are coming out with an amazing revolutionary new project, a platform of some sorts, or any other enticing promise.

The premise is that their promising something in the future and selling their idea to investors. As the price of their token increases, they sell all their tokens they gave themselves during the start of the token launch.

This method tends to happen very slowly as time is needed to build up hype and, of course, wait for the price of the token to increase.

3. By removing your ability to sell

Developers can in fact add code which will literally not allow their users to sell their tokens back to the decentralized exchange and, of course, leave themselves out of it.

This means that the price of the token is only bound to increase as no one can sell their tokens, even if they wanted to.

When the price is really high, the rug pullers will sell the tokens which they either gave themselves or bought early on at a very, very low price.

So, what can you do to avoid a rug pull?

As a rule of thumb, we try to answer at least the 5 following questions

1. Is there locked liquidity?

Many developers will lock up their liquidity with a trusted third party to ensure that they can’t pull out even if they wanted to.

Pay close attention to how long that liquidity will be locked as it will attest their commitment to their project.

However, the price can still be manipulated.

2. How big are their wallets?

By using handy tools blockchain exploring tools like Etherscan, you can find out if large percentages of the coins are being held by a few wallets.

If that is the case, it is very likely that the developer has bought a lot of tokens during the initial launch at a very low price.

However, even if that isn’t the case, large wallets are indicators of whales. Whales can still crash the price by selling considerable amounts of the token.

3. How big is the burn wallet?

The burn wallet can have a large percentage of tokens as means of hiding the whales who hold the actual big wallets.

Burning means sending tokens to an address which no one controls, meaning, getting rid of them forever.

If out of 1,000,000 tokens, 900,000 get burned, someone who is holding 10000 tokens will seem to be holding 1%, even though that 1% will in fact correspond to 10% of all tokens in circulation.

4. Was the project audited?

Projects will have independent third parties will perform audits as to attest their authenticity. If a project you are looking at hasn’t been audited, consider it a major red flag.

Does the project have a functioning website and social media presence?

Anyone can create a token but having a website and establishing social media presence takes time and effort. By doing so, developers can get credence to their projects.

5. Are the developers’ wallets “multisig”?

If there is a whole team working on a project, one person can withdraw all the funds. By having multiple passwords, for any transaction to happen, multiple passwords from multiple people are needed.

Wrapping up

The crypto world is hardly regulated and, by having no one held responsible, mischief and wrongdoing are to be expected at times. Moreover, anonymity perpetuates this type of behavior.

Hopefully, this guide really ties the room together and by using it, it will be easy to avoid a rug pull now. Just remember to pay attention to the signs before jumping in and definitely don’t fall into the hype and FOMO combo.