DeFi "Rug Pull" incidents are rampant, how to protect your funds safely?

Checking the liquidity pool and researching the history of the founders of a DeFi project is a prerequisite before participating in the project.

(This article is authorized for reprint from ChainNews, the original title is "DeFi 'Rug Pull' risks increase, how to protect your funds?," original article here)

"If you don't understand the pros and cons of the cryptocurrency projects you have invested in or plan to invest in, you may be surprised by market manipulation, smart contract errors, or any black swan event, and ultimately you may lose your hard-earned money. So, doing your own research (DYOR) is always advisable."

One recent "Rug Pull" incident in the cryptocurrency industry is:

The TITAN token price dropped to zero, with the project claiming to have "experienced the world's first large-scale cryptocurrency bank run." People kept cashing out, causing the token price to plummet. When people started redeeming the initial collateral, a rush to sell began. This led to a domino effect, with more and more players choosing to exit the game, causing the TITAN price to plummet severely within hours. Billionaire investor Mark Cuban also suffered heavy losses, although he claimed his investment in the project was "only a small part."

This bank run issue is one of the relevant risks that all DeFi investors need to consider. So today, I want to decode Rug Pull for you in the hope that it will help you make wiser investment decisions in the future.

So let's start understanding:

What is a Rug Pull?

The image above bluntly illustrates this phenomenon.

The crypto world accommodates several blockchain-based, DeFi, DEX, DApp, and smart contract projects that provide new tools for ordinary people to invest and grow. The dream of financial freedom has never been more within reach, as the crypto space offers new hope and power to individuals to exercise and change their destinies.

However, all these enticing promises also come with unexpected risks. If you are not responsible for your investments, these risks may shatter those dreams. There are always "bad actors" who wish to manipulate this largely unregulated cryptocurrency market for their selfish gains, potentially putting others' lives in jeopardy.

DeFi platforms are most susceptible to such malicious intentions and, being largely unregulated, are easy targets for such attacks. Therefore, as a retail investor, you may be risking losing all the funds staked or pooled in these DeFi projects, a risk known as a Rug Pull.

A Rug Pull is a malicious manipulation in the cryptocurrency space where the owners (developers) of a DeFi project may abandon the project and run away with investors' money, often citing software fixing issues as their excuse.

Rug pulls are most common in the DeFi ecosystem, with decentralized exchanges (DEXes) being the biggest victims. Many new DeFi projects create their native tokens, pair these tokens with popular tokens like ETH, USDT, DAI, and allow users to exchange them, attracting investors with higher returns. As the number of investors grows, they may "rug pull" with the established ETH/DAI/USDC/USDT pooled in the protocol.

Malignant developers find it easy to create DeFi platform tokens as these platforms offer the freedom to do so without the need for approval for listing every token on their network. These developers mainly use the Ethereum blockchain as it is open-source and follows the ERC-20 standard, making token creation effortless.

How to Identify Such Projects and Safeguard Your Funds?

Check the liquidity pool of a given DeFi project:

A simple way is to check the liquidity of a specific project's pool. Higher liquidity is a sign of the strength of a DeFi project, but this does not solve all problems; you should also look into the project's development history and the team behind it.

For example, UniSwap, Bancor, AAVE, Compound have been operational for over 2-3 years and have sufficient total value locked in their DeFi ecosystem, making it relatively safe to provide liquidity to these projects.

Always research the founders' history:

Never blindly follow any news or rumors and plan investments, or stake your tokens for higher returns. Always deeply research who the founders of the DeFi project you wish to invest in are. Who is backing those projects? Are there any past issue reports against them and more similar questions?

Check token lockup periods based on DeFi liquidity pools:

Liquidity pools are the backbone of any DeFi project. Without sufficient liquidity, they cannot provide services like token swapping, Automated Market Maker (AMM), crypto lending, liquidity mining, etc. All these services collectively power the DeFi engine, requiring adequate liquidity in the relevant pools for smooth operation.

Therefore, make sure to understand for how long the platform enforces a lockup period on tokens in the pool. Most reputable and trusted projects lock liquidity for a period to protect investors' interests.

Sudden fluctuations – Token price skyrocketing

One speculative risk is when the token price in a given liquidity pool suddenly skyrockets.

So, if you notice a token price suddenly rising by 50 times or 100 times, you need to be cautious of such speculative behavior as it may be a trap triggering what is known as FOMO to attract more investments.

Beware of high rewards:

Newly launched DeFi pools may offer high returns on staking your tokens as they also aim for higher liquidity. However, when any project starts offering unexpected returns of 500% or 1000%, you need to be cautious as this is abnormal for seasoned DeFi players.

So, remember the saying, "All that glitters is not gold."

Keep this in mind and make decisions with utmost caution.

Some major "Rug Pull" events from the DeFi space:

• Messari Report: Since 2019, DeFi hacks have caused over $284 million in losses, with an average of $11.9 million stolen in "Rug Pull" events.
• Thodex: In 2020, the Turkish cryptocurrency exchange Thodex, with around 400,000 users, was accused of exit scamming. The Thodex website shut down, claiming to be "temporarily closed to resolve abnormal fluctuation in the company accounts." It was alleged that the CEO of Thodex ran away with $2 billion of customer funds and fled to Turkey.
• Meerkat Finance: This DeFi project consumed crypto assets worth $31 million. On their official Telegram channel, the team claimed their smart contract vault was breached.

Conclusion:

Many such events are being identified and reported, so given the rise in bank runs, rug pulls, and exit scams, you need to be more responsible with your investment strategy, do your homework well, 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 clear-minded, cautious investor, you will spot many issues, calculate risks, and sleep soundly with your money.