Non Fungible Tokens (NFTs) are the hot investment right now, but they have a hidden danger. Some people will sell you NFTs that aren't worth what they claim. They do this by closing down after the sale is over, so they can't be held accountable. This is called a rug pull. They've pulled the rug out from under you and absconded with your money.
This article will explain the NFT space to you, how it works and how to avoid 'rug pulls,' a relatively new concept that isn't explained on the Internet yet.
What is a rug pull?
A rug pull, also known as an exit scam, is a simple yet effective form of fraud in the NFT market. In a rug pull, an artist sells fake NFTs on an NFT platform using a special kind of smart contract. Tangible assets do not back these tokens but rather "smart contracts" that essentially self-destruct after a certain amount of time has passed.
When someone buys one of these NFTs, they're essentially buying nothing. It's just vaporware (i.e., a product that has been heavily advertised but is not yet available and may never be.). The only real thing that happens is the buyer deposits Ether into the smart contract, and the creator withdraws it. The creator can then run off with the funds or even sell them to another buyer before any traceable information becomes available about where they came from.
The term comes from the way such an investor feels when this happens. They may feel like they've been sold a defective product, but more importantly, they feel like the metaphorical rug has been pulled from underneath them - that they were tricked into buying something.
In what ways can cevelopers or founders rug pull (Scam)?
Blockchain projects are not governed or owned by any entity as they are distributed systems. So, no one is responsible for curating the source code of dApps, smart contracts, and tokens. However, such openness is a double-edged sword as the developers/founders of these projects can change the source code of the dApp, smart contract, or token anytime they want to do so, whether to add a new token feature or fix a bug, or rug pull.
There are multiple ways in which founders/developers can rug pull through whitelisting or blacklisting certain addresses, limiting the number of wallets that can withdraw funds from their platform.
These are a few different ways that developers and founders can rug pull:
The most common way is to mint many of the project's NFT tokens and sell them to the community at low prices. Then, once the community has bought into the project, they announce that they are rug pulling, taking all of the money they have made on their NFTs, and dumping them on the market.
Some projects will also rug pull by burning their token supply. This is usually done in conjunction with fake announcements or other news that make it seem like their project is succeeding. But once investors start buying into the hype, these projects will burn their supply and dump on their investors.
Some projects try to rug pull a third way by creating fake NFT markets for their tokens. These markets are usually not backed by any real liquidity pools. These fake markets can often be complex for investors to tell apart from real NFT marketplaces. Furthermore, once an investor purchases an NFT from one of these fake markets, it can be extremely difficult or impossible to sell again.
Another common way developers/founders rug pull is when they create a token that isn't backed by real-world assets and then dumps their tokens on the market. They can also do so by making unannounced changes to the underlying code of a smart contract.
Other methods include having an unknown developer/founder and not providing any information about other team members. There's also a lack of communication with the community and no roadmap for the project after several sales then remove their work from the market.
How to avoid being scammed?
There's no way to prevent rug pulls. Creators can permanently remove their work from the market if they want to. But there are some things that you can do to mitigate/reduce your chances of buying into a rug pull:
Check who's selling it
Some of the most high-profile NFT sales have involved artists new to the space. That's great for the space at large, but it also means there are people out there who know less about NFTs than the average crypto user, which can be a problem.
One good way to avoid getting scammed is to check who's selling it. For example, if it's your favorite artist, make sure they promote and sell their works. How do you verify that? You can look at the announcements made by the artist or team account on Twitter or Telegram, for example.
Ensure its unique
Make sure you know how many copies of that work or asset before buying it. Being sold as a limited edition isn't enough. Also, make sure there aren't 20 other copies circulating the Internet or resold on secondary markets like OpenSea.
Make sure it can be sold on secondary markets
Some NFTs are only intended to be sold on a specific platform. If that's the case, make sure you're comfortable with only being able to sell on that platform in the future. If you want to sell your NFT on any market, it says "ERC-721" or "ERC-1155" under the product details section; these are the types of tokens compatible with all NFT marketplaces.
Consider whether it's a good investment
Just because you can buy something doesn't mean you should. Before making any investment, please do your research to determine whether it's a good bet for your money. This is particularly important when buying art. Not every piece of art will appreciate over time, so buy what speaks to you and not what might be a good investment.
Look for established artists who have a track record
Another way to avoid benign scammed is to look for established artists who have a track record of selling on Rarible. This is far from guaranteed, but it does increase your chances of avoiding a rug pull. The more sales an artist has made, the less likely they will pull their token contract from the blockchain and delete their creations.
Look for signs of collusion and other red flags. For example, if multiple founders are all building together but have not announced it publicly, they could be conspiring to dump everyone else. If they're all building on separate projects, they're less likely to be involved in collaboration if the team has a history of rug pulling.
Notorious rug pulls in crypto history
There is a saying in the crypto space: "It's not a matter of 'if' it's a matter of 'when'" when it comes to being scammed. It's very accurate in the sense that there are people out there who will try to find an opportunity to take money away from you.
Here are a few notorious rugs pulls that have been experienced in the crypto space:
OneCoin
OneCoin was a Ponzi scheme that defrauded investors out of $3.7 billion. It claimed to be a cryptocurrency and blockchain project but was a pyramid scheme that paid commissions to earlier investors using money paid by new ones.
Affiliates invest on the promise of advertised returns. The OneCoin website does not provide any information about who owns or runs the business, nor do they have an "about" section; however, no information about its ownership structure is provided.
BitConnect
BitConnect is another famous rug pull of all time. Launched in late 2016, BitConnect was a cryptocurrency that promised the world: highly high returns and the ability to lend your money to the company to earn more.
It promised returns that were not sustainable. They could only pay out people who had invested earlier by asking newer investors to keep paying in. As long as people kept investing, they could keep paying out high returns. But once people stop investing, it is game over.
Bitclub Network
This one is probably the most notorious rug-pull in cryptocurrency history. First, a Ponzi scheme raised roughly $722 million worth of Bitcoin. Then, it used a multi-level marketing scheme to create a pyramid structure. BitClub Network was said to be a mining pool. However, the "mining" operation was a sham, and the mining equipment purchased with investor money was never used in any mining operations.
Squid Game Token
Squid Game Token's project was supposed to be a platform for gamers, with tokens being used as rewards for winning games. Squid Game Token's developers raised around $300,000 through their initial coin offering (ICO) and then disappeared. The Squid Game Token website went down, and the developers deleted their social media accounts.
Conclusion
It's possible (and relatively easy!) to avoid rug pulls when buying NFTs, but it does require some legwork. Fortunately, there are resources available for eager investors who want to make sure their NFT purchase is legitimate before committing their ETH to a smart contract. The primary issue with fake tokens is that there is no way to report them and remove them from existence like a centralized game or platform. So investors must use diligence, ask questions, and investigate for themselves.
