Scams have been a part of commercial enterprises since the invention of money. Essential oils, buttery soft leggings, penny stocks, adjustable-rate mortgages, single-drop blood testing tech, and three-card monte all follow a similar pattern.
The difference between a scam and life-changing wealth can be difficult to decipher, but the good news is that the blockchain makes these lies transparent rather quickly. In this article, I’ll review some of the things I look for when evaluating shitcoins, DeFi projects like Liquidity Pools, and Non-Fungible Tokens (NFT’s). Trust me. I’m your Gganbu.
TL;DR: Rug pulls and scams exist in the crypto world. If you don’t want to read my article, feel free to check out the video below.
What is a rug pull?
Rug pulls, also known as pump n’ dumps, are when an asset’s value is disingenuously inflated, only for those that have been doing the inflating to run away with the inflated value. This leaves everyone else with valueless assets. This happens in the NFT space, liquidity pools, and shitcoins.
Shitcoins are the original crypto scams after Bitcoin gained popularity, and riding on the coattails of the 2017 ICO (Initial Coin Offering) boom. Onecoin and Bitconnect are the most notable examples and are considered Ponzi schemes. Bitconnect claimed that users could lend their coins out for incredibly high interest rates powered by a trading bot with little transparency.
Bitconnect’s claims may have become a reality with the advent of actual transparent trading protocols providing even higher returns than those claimed by Bitconnect. As I currently reside in a state with rather prohibitive cryptocurrency laws, I’ll refrain from naming these protocols but if you are a fan of Greek mythology, you can use Google to find the DAO (Distributed Autonomous Organization). Could these new DAO’s and protocols also be rug pulls? Absolutely.
Shitcoins were often sold on websites in exchange for valuable coins like Ethereum and Bitcoin. It was a way to exchange something of no value for something of value. Liquidity pools offer similar opportunities for scammers.
What’s a Liquidity Pool?
Liquidity Pools (LP’s) are protocols that act like a foreign exchange bank as a vending machine. As an investor in an LP, users would deposit equal values of two coins. For example, if one were to start an LP with Bitcoin and USD, they could put in 1 BTC and the dollar equivalent. Whenever someone buys one currency, they would have to deposit the other currency in addition to a nominal transaction fee which is returned to the investors of the pool.
The Liquidity Pool as a Rug Pull
Scammers take advantage of this mechanism by releasing (shit)coins onto decentralized exchanges that house many liquidity pools and pairing the shitcoin with bluechip coins of value like ETH, BTC, or a stable coin like USDC or DAI. If the shitcoin producer has enough bluechip coins, they can fund the liquidity pool for themselves, hype up the coin, and move suckers to purchase the coins from the LP. They may even buy their own shitcoins out of the LP to artificially raise the price of the shitcoin, creating momentum for others to ape in.
Once there is good momentum in the price movement and the shitcoin appreciates in value, the scammer can then use the same liquidity pool to sell their shitcoins and remove all value from the LP. This leaves everyone else holding the shitcoin bag with a valueless coin and a dead LP.
How to spot a Liquidity Pool scam?
Read the documentation or whitepaper. Most documentation is meant to be read by the average person. The Bitcoin Whitepaper is actually fairly approachable and one does not need to be a comp-sci major to understand it. Most whitepapers are similarly approachable and explain the mechanisms of the technology. Technology that has little or no documentation should be viewed skeptically.
Check the developer's holdings. The great thing about cryptocurrency is the transparency of the network, so humans can use block explorers like ethscan to view a developer’s holdings. Developers with disproportionately large holdings of a coin should also be viewed with skepticism, as they may be well equipped to pull an LP scam.
Check the code. Transparent projects normally expose the code for inspection. Does the code match up to the claims made by the whitepaper? This step may not be accessible to most, and one reason why the current technology divide is quickly becoming a wealth divide, but I will leave that for another blog post.
As I am writing this article in October of 2021, NFT’s are all the rage and may very well be the greatest wealth multiplier in the space. They are also full of scams. NFT’s are unique digital assets that are often valued for their rarity or uniqueness.
Similar to shitcoins and LP’s, NFT scams usually center around creators releasing a project as a drop and quickly abandoning the project once the original minting is sold out and all value has been collected. Scam NFT projects can be identified by analyzing the art, the team, the community, and the roadmap of the project.
Check the art. Scams often steal art from other sources, which would immediately ensure that the project loses value as it is not original or rare. NFT’s are valuable because of the promise of rarity, and a project consisting of stolen artwork from another source is not rare, or simply theft. One can simply use Google’s reverse image search to see if the art is copied, or if it’s original. This does not guarantee originality, but it can usually catch shady actors pretty quickly.
Check the team. Most NFT projects are anonymous due to the lack of regulation around NFT’s. No one is sure how governments will treat the technology, so most teams prefer anonymity in case they are prosecuted for violating rules in securities and exchanges. Teams that have a track record or are doxxed are more attractive because there is personal accountability for their projects. Gary Vee’s VeeFriends is a good example of a transparent creator in the space. Teams that are inactive or shady on Discord and Twitter should be viewed as red flags.
What does the community look like? If the community is not growing, or it looks like users or Reddit upvotes were purchased, approach with caution. Quality NFT projects will have organic growth, which can be monitored in their discord channels and Twitter followings. If it looks like their followers are mostly bots, consider that a red flag.
Is the roadmap realistic given the creator's background? NFT roadmaps can take many forms and can make audacious claims about the future. If a project sets a few milestones and does not deliver on them, that should be considered a red flag. Radio silence in regards to progress on the road map should also be considered a red flag.
Transparency and due diligence has your back
It’s easy to believe that crypto scams are the norm, but the transparency provided by blockchain technology is unprecedented and scams are often quickly revealed because of this. Opportunities can be balanced with due diligence, and charlatans can be avoided.