Yield Farming Chapter Nine - Rug Pulls

This is Chapter Nine, focused on Rug Pulls, in a series of articles that will be released about yield farming. The purpose of this series is to introduce the concept of yield farming to those who are unfamiliar with it, then move into various yield farming strategies and finally step-by-step walkthrough of the process. I hope you enjoy the series and any feedback you have would be greatly appreciated.

Chapter Nine - Rug Pull

Rug (noun) a floor covering of thick woven material or animal skin

Pull (verb) exert force on (someone or something) so as to cause movement toward oneself

A rug pull occurs in the cryptocurrency industry when developers abandon a project and take the investors' funds with them.

What is a Rug Pull?

A rug pull is a scam done by a projects development team in which they stop working on a given project and take all the money within with them leaving investors with nothing. In most cases the developer(s) pump up the price of a project and drive the price down to zero after taking out all the funds.

Since rug pulls involve the developers of a project, it is important to have a good feel for the team behind any project you are looking to invest in.

Types of Rug Pulls

There are three main types of rug pulls in crypto, pump and dumps, limiting sell order and liquidity stealing. It is important to understand the basics of each type of rug pull in order to avoid them when yield farming or dealing with any crypto platform.

  Pump and Dump is a term used to describe a scheme when a developer gets the price of a token to a certain level (pump) and then sells off a large number of their own tokens (dump) which drives the price down to a virtually worthless amount. The developer cashes in with the profit while investors are left holding the bag.

  Limiting Sell Orders occurs when the developer adds code to a project which only allows the developer to sell the underlying tokens. In liquidity pools, there are two paired tokens for trading between the two tokens. Once the price action gets to a certain point, the developer sells their LP tokens, much like in a pump and dump scheme, leaving the LP pairs worth next to nothing.

  Liquidity Stealing is similar and occurs when the developer removes all the tokens completely from a liquidity pool. This is the most common form of rug pull within yield farming in decentralized finance and results in a token price of zero.

Rug pulls are considered either "soft" or "hard" in the crypto world. Soft rug pulls are when a developer dumps the tokens and deflates the crypto price as in a pump and dump scheme as described above. Hard rug pulls occur when a developer inserts malicious code into a project, often from the outset, allowing them to simply take all the investors funds as in a liquidity stealing exploit.

How to Avoid a Rug Pull

Even the most knowledgeable crypto investors can be a victim of a rug pull. This is one of the reasons you should always diversify your holdings and stay away from the "all your eggs in one basket" situation. There are, however, several things you can look for as part of your research to help reduce the risk of getting involved in a rug pull.

  Know the Developer(s) - the best way to avoid a rug pull is to understand who is behind the project. Has the team been "doxed," meaning has their identity been made public. Fake social media accounts and profiles are easy to make, so it should be deeper than that. Anonymous developers should always be seen as a red flag. What projects has the developer(s) worked on before? Is the website and  the whitepaper professional and free of grammatical errors. 

  Locked Liquidity - if the liquidity within a project is not locked on the token supply the developer can easily take the money and run. You want to find a project that has liquidity in smart contracts that are time-locked. The higher the percentage locked, generally the safer the project. Almost all projects list a TVL (Total Value Locked) figure that is ideally at 80% or more of all the value in the project.

  Crazy High Yields - we are involved with yield farms to make money so the higher the yield the better. Not exactly, many farms do start out with very attractive yields that tend to fall as more and more liquidity is added to the pool. But if something looks too good to be true, then it probably is. The more you look at different yield farms the more familiar you will become of the rates of return.

  Wild Price Swings - huge price swings in a tokens price are a red flag. This is especially true of a project with limited token holders. The smaller the number of holders, the more cautious you should be of the project. You can check out the number of wallet holders in a project on the network on sites like Etherscan on the Ethereum network and BscScan on the Binance Smart Chain network. The developer isn't the only one who can swing prices, a "whale" or wallet holding a large number of tokens can manipulate token prices through the AMM algorithm. 

  External Audit - while an external audit does not guarantee a project won't rug pull, it is the step in the right direction. If a project has been audited by a third party, it should be apparent on the website and verifiable. A good audit should confirm no malicious code was found in the review. Projects with multiple external audits should be seen as more desirable than a project with no audits.

Whiteboard Crypto YouTube Video - What is a Rug Pull in Crypto?

Previous Chapters

Yield Farming Chapter One - What is Yield Farming?

Yield Farming Chapter Two - Decentralized Finance

Yield Farming Chapter Three - Automated Market Maker

Yield Farming Chapter Four - Liquidity Pools

Yield Farming Chapter Five - Smart Contracts

Yield Farming Chapter Six - APR vs APY

Yield Farming Chapter Seven - Gas Fees, Slippage and Other Fees

Yield Farming Chapter Eight - Impermanent Loss