Detect fake crypto projects and pump-and-dump schemes

Of this, more than $2.8 billion was lost to “rug pulls” or “pump and dump” schemes, which account for the lion’s share of the total illicit cash taken from the crypto market by bad actors and developers.

Rug pulls are when a token creator artificially inflates the price of a cryptocurrency token, abandons the project, and then absconds with investor money.

They are characterized by a disproportionate increase in the price of the token.

Pump and dump schemes represented only 1% of all cryptocurrency fraud by value in 2020, but by 2021 they had increased to around 36%, indicating a significant problem for crypto investors worldwide.

What method of operation does a pump-and-dump crypto scheme use?

For blockchain initiatives with specialized use cases, such as decentralized finance (DeFi), gaming, media and entertainment, crypto tokens serve as a medium of exchange.

These tokens are created under specific situations, such as when validators on the underlying blockchain participate in the consensus procedure, in accordance with a preset supply mechanism.

Token developers occasionally include security flaws in their programming, allowing them to steal money without investors’ knowledge.

These so-called “hard rug pulls” involve the project’s creators fleeing with the funds raised for further project development and are usually carried out during the first token sale period or right after.

Soft blanket moves, on the other hand, take place when developers dump tokens on cryptocurrency exchanges, driving the token’s price down.

Although not technically illegal, soft carpet covers are usually far easier to detect than hard carpet covers, as they make it clear that the project’s developers had ulterior motives.

When the developers of the SnowDogDAO project decided to conduct a buyback exercise, they moved to a special market maker platform called SnowDog AMM and sold the original SDOG token before most investors could even react to the sharp price drop.

A pump-and-dump scam is far more likely to occur when investors rush to buy the underlying token without considering the project’s fundamentals, so investors should be wary of initiatives that make big claims.

Types of carpet covers

There are three main types of pump and dump schemes: dumping, limiting sell orders and direct liquidity theft.

All pump-and-dump schemes give investors either no tokens or a token that has been significantly devalued.

Dumping, a tactic where the developers of the token themselves sell all their token holdings at the peak of investor demand, is more likely with projects that have quickly attracted a lot of investor interest.

Investors can identify these initiatives by an excessive amount of advertising on social media or by additional premiums that may seem too generous.

Similarly, liquidity grabbing has become the primary method of stealthily removing investor funds from DeFi projects that have a lot of value locked up in liquidity pools where investors stake their tokens in hopes of earning market-beating returns on their investments.

Since these funds are directly tied to the token’s value, liquidity grabs have a ripple effect on the token’s price that eventually drives it to zero when investors want to sell or withdraw their tokens.

Sharat Chandra, VP of Research and Strategy EarthID says that a much more advanced type is when developers limit the number of tokens that can be sold by token holders or the speed at which they can sell them.

Such tokens can rise to remarkable amounts in a short time since investors are limited in their capacity to sell their holdings, which is usually introduced as an anti-dumping feature.

As a result, a fictitious demand-supply gap is produced, giving creators the advantage of being able to sell tokens whenever they want.

“The introduction of the Squid Game token last November served as a great illustration of this type of blanket pulling, with the SQUID token surging to over $3,000 just a few days after launch. However, due to an anti-dumping mechanism incorporated into the token, investors were unable to sell any of the purchased tokens. As a result, the creators of the project sold all their token holdings at the height of the craze and seemed to have escaped unscathed, says Chandra.

Avoid such arrangements

Raj A Kapoor, founder and CEO of the India Blockchain Alliance says that while there is not much investors can do once they have invested in a token that is the target of a pump-and-dump scam, there are warning indicators that they need to be aware to avoid becoming a victim in the first place.

“A few clear symptoms of a fraudulent cryptocurrency project include the guarantee of remarkable profits, projects created by unidentified parties, restrictions on sell orders and one-way price movements,” says Kapoor.

Another indicator of a coming blanket move and one that can be easily spotted by investors studying the token’s whitepaper are elements such as weak or no liquidity being locked up by the project creators.

However, more sophisticated techniques, such as changing the token’s code to the developer’s advantage, can be challenging for less experienced investors to notice and can only be prevented by looking at the developer’s past experience.

The best way for cryptocurrency investors to protect themselves against such pump-and-dump operations is to thoroughly research the project’s “tokenomics” and steer clear of tokens issued by developers who have no previous track record or experience in blockchain projects.

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