How to analyze liquidity pools and other factors to avoid falling victim to rug pulls | by Audrey Nesbitt | October 2022

How to analyze liquidity pools and other factors to avoid falling victim to rug pulls

Rug pull is a term that everyone in the crypto sphere fears. It is one of several scams used in the crypto industry by bad actors to make a quick buck. Unlike hacks and other scams, rug pulls are almost always an inside job, with the developers (as a whole team or one or more members fooling the rest of the team) getting away with the investors’ hard-earned money and leaving it to them worthless tokens.

According to research, more than $48 billion has been skimmed through over four hundred carpet trains to date. Because of this, many are wary of investing in digital assets. The question is, can carpet pulling be detected and avoided?

Before learning how to avoid becoming a victim of rug pulls, one must understand what exactly it is. The term comes from the saying “pulling the rug out,” meaning to pull out of a situation abruptly, leaving others dry. In the DeFi and crypto industries, the shortened version “rug pull” is used to describe a similar situation where a cryptocurrency developer or team suddenly walks away with the entire investment.

The method. is usually the same for all rug pulls, where a new token is dubbed the next golden goose by the team behind it, creating hype to attract investors. The team is pumping the token’s (fake) properties across various social media channels, attracting people with hollow but compelling promises that the token will soar to unprecedented values ​​in the future. The goal is to bring FOMO (Fear of Missing Out) to a level where the public is convinced that this is the best way to get into crypto gambling.

Unlike the 2017-2018 ICO era, where investments in token launches were more or less centralized, rug-pull artists have leveraged the use of smart contracts on DEXs, or decentralized exchanges, to run their scams. They can market the contract as an effective promotional tool and say that the invested tokens are held in a smart contract and they have no control over it. The final distribution and/or liquidity is controlled by the contract itself according to the value of the deposited assets.

Crypto startups that have a token that will be used to raise funds for the project need to generate a market for the token. This token can also be used to pay team members, consultants, influencers, ambassadors, etc. Once all the tokens are pre-sold, the startup needs to get the token onto a marketplace for them to be bought and sold. The first marketplaces available for this are decentralized exchanges or DEXs such as PancakeSwap or Uniswap.

The “how” lies in how liquidity pools work in DEXs. To enable a startup token to be traded or sold, developers create a liquidity pool in which the new asset is exposed in exchange for a more common token, such as WETH, USDT, USDC, and BNB.

To start the pool, the developer needs to add the liquidity for both tokens, for example their token and BNB, into the pool. If it is a scam and the carpet puller sees that enough crypto investors have bought the fake coin from BNB, the developer will withdraw all the funds and walk away with the valuable BNB. What remains are worthless tokens in the hands of dissatisfied investors.

With nothing stopping token developers, it’s easy to become increasingly paranoid as virtually any new token on a DEX can potentially be a carpet pulling. Don’t give up: There are things a savvy crypto investor can do to drastically reduce the chances of becoming a victim of a carpet pull.

Do your own research to find out if the project is legit. Look for things like the identity and reputation of the teams, read the whitepaper, and research if there is support from major crypto VCs. And don’t just take what the website says is “real”. Find team members on social media and contact them to make sure they speak publicly about the project. Google for information about a project outside of their own website and social channels and see if there are any threads on Reddit. Note that there will be token schillers.

The token and project in question should also have an actual purpose or benefit and address a pain point or gap. Many projects only sell tokens for fundraising purposes when the project could run without token gating.

This entertaining video, How Dapps Work in 2018 ~ “Dawn of the Dapps”, by the team at HiFi Lending/Mainframe touches on the token dilemma faced by many projects. It raises the valuable question: How do you scale when you only accept cryptocurrency as payment?

Avoid investing in projects where the majority of tokens are held in just a few wallet addresses. The fewer wallets hold the token, the greater the likelihood that they can distort liquidity through pumping and dumping.

To verify the details for each wallet, copy the token smart contract address and paste the appropriate block explorer (e.g. BSCScan.com or EtherScan.io for Ethereum). Go to the token tracker section and tap on the “Holder” to view all the wallets that contain the token. And be sure to check the comments section. There can be a lot of spam here, but if the token is a scam you will see multiple posts about it.

Alternatively, a great tool is available to help DeFi investors filter through all the information available across different platforms. FLUIDEFI is a project created by a team of DeFi traders who wanted to reduce the hours spent researching, tracking, and managing their portfolios. The FLUIDEFI platform shows the number of wallets and active positions in a liquidity pool. It also shows the average position and investment.

FLUIDEFI: Active wallet positions

FLUIDEFI tells the user exactly how many wallets and positions add liquidity to the pool. If a large TVL portion of the pool is owned by multiple wallets, there is a high risk of carpet tearing occurring.

In this example, users can see exactly who is invested in a UniswapV3 pool ((WBTC – WETH) and their position size. Since this pool (WBTC – WETH) has many liquidity providers, none of which have a significant stake, it is more credible.

FLUIDEFI – DeFi investment technology

Legitimate projects inject a few lines of code into their liquidity pool smart contracts that deny developers the right to access and drain the funds. The liquidity pool lock is the first thing an investor should check. Understandably, investors are highly unlikely to be able to analyze smart contract coding, but there are platforms like DXsale and Unicrypt that can come in handy here. Simply copy and paste the liquidity pool smart contract address into any of these websites and you will be notified via their platform if a blocking mechanism is in place. Watch out for a short-term freeze on liquidity. Sometimes scammers just “lock up” the tokens for a few days, and when the time is up, they pull the carpet off.

Another great site is TokenSniffer. An easy to use tool – just copy and paste the token contract address into the search bar and TokenSniffer will provide a quick contract review, exploit information and more. The site also has a list of known scams and hacks, which is a good place to go before you buy a token to see if it’s on the list.

You can also check out the PooCoin.App. Here you can use the Dev Wallet Checker, which is an activity log related to the token from all wallets that owned the contract. It shows all instances where the developer creates and removes LP, buys/sells the token, transfers tokens/LP tokens/BNB to other wallets and transfers ownership of the contract.

Rug pulls are becoming more and more complex and can disguise themselves better and better. However, with the above strategies and DeFi tools, anyone can assess whether a token is a scam or not, allowing them to reevaluate their investment decisions and choose less risky options.

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