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Last updated Jun 27, 2022 at 6:25 PM
Posted Jun 17, 2022 at 4:00 AM
Cryptocurrencies can be very lucrative but they also have nefarious volatilities. Suppose one day your friend suggests a coin with low market capital which is rising 2, 5, and even 10 times a day. Numbers convince easily, right? So you decide to jump on the trade and the coin or token shows you some green candles until the worst happens. One morning you wake up and find out that the price has plunged to almost zero. Since the team is anonymous, there is no way to get even your investments back. This is so super annoying that you want to quit cryptocurrency trading forever. What actually happened to you was a crypto scam – the infamous Rug Pull.
What is a Rug Pull?
A Rug Pull is used in cryptocurrencies when investors or developers run away with all the investments in their projects. People create the projects with malicious intent and convince investors and buyers to put their money in. When there is enough money in the project, they just bag it and disappear. This recently happened with the Squid Game Token. That token peaked to more than $28,000 before plummeting to zero on November 1, 2021. Squid Token gained more than 83,000% in a few days, turning pennies into millions, but unfortunately no one was able to withdraw their funds.
CoinMarketCap tried to alert people but greed took over. Binance has opened an investigation into the scam and any credible output is still awaited. Surprisingly, the token is up and live with a new team of developers and managers. The Squid Game official Website states that this token was created by scammers and the new team has blacklisted their contract addresses.
To understand this kind of liquidity approach let’s first understand what ‘Liquidity’ or ‘Liquidity Pool’ means. A liquidity pool is a smart contract where assets are locked to help traders process their trades at the desired prices.
In the finance and crypto trade, the buyers and sellers book their orders in the order book. When the price asked by a seller reaches the bid price of the seller, the trade is executed. A buyer comes with money and records the order with the quantity of the asset required and the seller records the order to sell at a certain price for a certain quantity, as highlighted in the above image. When the trade is executed, the seller gets the money and the buyer gets the assets. The image below shows buyers and sellers in Bitcoin trade on Binance.
Simple! But what if there are no sellers?
That’s where Liquidity Pools come in. These Liquidity Pools have both assets locked in with a 1:1 ratio. This Liquidity Pool leverages an algorithm to find efficient trades no matter how high or low the price of an asset is. If there are more assets in the Pool, it will be difficult to alter the price. To stabilize the price, the crypto ecosystems encourage investors to lock their funds in the liquidity pools in return for the interest collected as fees. Crypto ecosystems offer lucrative APRs, as high as 1000%, to win investors, but that’s where the trouble begins.
What scammers do is create a liquidity pool of a valuable token with their developer token, which needless to say is worthless. When people put their money into the liquidity pool, the price of their token keeps rising because of the increased liquidity due to the market makers. At some point, when the price of the token is high – boom!!! Rug Pull happens and the scammers withdraw their token value leaving nothing in the pool to trade.
All crypto coins are a piece of code and we trust the developers to be fair and honest as not all coins or tokens are open source. Developers can write anything in their code including not authorizing the buyers to sell their tokens at any point. By this approach, anyone can buy the tokens but only developers are able to sell them. In this way, the price of the token only goes up. The developers who bought a very large quantity at a very low price sell it when the price is considerably higher or the worst happens: they run away with all the money invested in the tokens.
This type of rug pull was implemented by Squid Token. The Squid Game token required another token to successfully trade it back. The second token could only be obtained by playing and winning a blockchain play-to-earn game whose entry fee at one point was $770. The buyers and investors were thus trapped with the token until the developers decided to rug pull.
Don’t fall for the numbers. DYOR (Do Your Own Research) before investing. Pay close attention to spot these signals. Remember, Squid Token coaxed people to buy by saying they wouldn’t allow them to sell normally so as to organically raise the price of the token. Check who governs the liquidity pool; use BSCScan or EthScan to check who owns most of the coin and tokensniffer to check the smart contracts. And if the team holds more than 5%, there is definitely something fishy there.