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By Sandeep Kasalkar
When a development team quickly abandons a project and sells or destroys all of its liquidity, it is known as a rug pull in the cryptocurrency industry. The term comes from the statement “pull the rug out from under (someone),” which means abruptly ceasing support.
The most commonly connected Decentralized Finance (DeFi) initiatives to rug pulls are those that provide liquidity to Decentralized Exchanges (DEXs). Since CEXs normally do not list DeFi tokens, a DEX is the sole source of liquidity for new projects’ DeFi tokens.
A DeFi startup will typically produce its token and give a certain quantity as liquidity to a DEX. This might be sold in an initial DEX offering (IDO) or immediately added to a liquidity pool (combined with another token like ETH or BNB) . Investors buy the coin in an IDO, and the money is often locked for a set amount of time to ensure a particular degree of liquidity.
Once the project has access to their funds and hype levels are high, the rug pullers have two choices. They can either remove all liquidity by selling their tokens at a high price, or they can even utilise back doors in smart contracts to steal investors’ money.
Investors struggle to sell their tokens or are compelled to sell them at a loss if there is insufficient liquidity. The Automated Market Maker (AMM) pricing system, which establishes prices based on the ratio of two currencies in a liquidity pool, is to blame for this.
In DeFi, rug pulls are frequent since tokens may be quickly generated and listed on DEXs with little to no KYC or AML. A liquidity pool can be created by anyone, and even an IDO with simple due diligence requirements faces significant risk. Due to the anonymity of many crypto projects, it is simple for a team or owner to execute a ruse without having to worry about their identity.
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