Recently, investors in the virtual Squid token (“SQUID”) stood by and watched while the value of their digital currency collapsed from a high of just over $2,860 to effectively a zero value. According to the Washington Post, the token’s creators withdrew approximately $3.3 million in funds, driving the price of the coin to near worthless. SQUID traded on PancakeSwap, a decentralized digital exchange. It quickly gained momentum among users because investors thought that the coin was somehow tied to the recent Netflix hit series, “Squid Game”. Soon it became apparent that there was no such connection. After climbing to a high value, all of the liquidity was taken out by its developers, leaving the investors holding worthless tokens.
What is a Rug Pull in an Initial Coin Offering?
In the cryptocurrency world, this type of maneuver is known as a “rug pull.” In a rug pull, the coin’s developers abandon a project and run away with investors’ funds. According to cybertalk.org., the most common type of rug pull is a liquidity scam. This fraud involves listing the digital coin on a decentralized exchange (DEX) and pairing it with a top cryptocurrency technology, such as Ethereum (ETH). According to cybertalk.org, the sequence of events in a typical rug pull would then continue as follows:
The token creators copy an existing, public smart contract code and issue a platform token. Then, they create hype for their project and add liquidity of the token to a DEX, like Uniswap, Pancakeswap, or Sushiswap. DEX’s allow users to swap tokens without any intermediaries. The paired tokens are locked in a smart contract called a liquidity pool. Using the DeFi exchanges, customers swap their tokens for the platform token.
With the token developers and initial platform users investing in the project, more and more people start seeing it as an opportunity to “get in early.” Once the token becomes popular and increases in value, the project owners dump their stake all at once to make a profit. This pump and dump leaves other investors with worthless cryptocurrency tokens and no option to get their money back.
Rug pull perpetrators like decentralized exchanges such as Uniswap, PancakeSwap, or Sushiswap because these alternative exchanges allow users to list tokens for free and without an audit.
This is very different from centralized cryptocurrency exchanges such as Binance or Coinbase. Centralized exchanges are similar to a traditional stock exchange where trusted middlemen handle user funds and facilitate trades. They are designed so that one entity manages closed liquidity pools holding large amounts of tokens and unique digital currency. Centralized exchanges are far more accessible, common, and easier to use. Decentralized exchanges remove this middleman and allow for direct trading between two users.
The SEC Warns Investors to Be Wary of Crypotcurrency Investments
The U.S. Securities and Exchange Commission (“SEC”) has warned investors not to get caught up in new digital currencies for fear of missing out (“FOMO”) on their dramatic rise in value. It suggests that investors considering a digital asset-related investment take the time to understand the program as well as to evaluate its risks.
The market is still under-regulated, scam ICOs are plentiful, and investors often have no protection if an ICO fails or turns out to be fraudulent. There is always a risk of fraud in cryptocurrency investments.
Things to Consider When Buying an Initial Coin Offering
If you are considering an investment in an ICO, look at the following before you buy:
- Review the creator’s team to see if they have any experience creating successful businesses. Generally, the team members should also list their social media accounts so you can contact them.
- Read the proposed project’s white paper to see how it will work, and understand when certain features will launch.
- Check to see if any relied upon computer code has been audited by a third party. This should provide data indicating that a project is serious about its security.
- Look out for typos on the website or white paper – this is often an early red flag that a website has be put together quickly and with little thought, and could suggest a scam.
- Beware of promises of large profits. This is a period of peak speculation in digital assets and investors are looking for the next get-rich-quick scheme. If its too good to be true, it probably is.
Generally, potential investors are less skeptical of an investment opportunity when presented with something novel, new or “cutting-edge.” While it may be that cryptocurrencies present an exciting investment opportunity for some, prospective investors should be mindful of the potential investment scams that are associated with their sale.
If you or someone you know has been the victim of cryptocurrency fraud contact a cryptocurrency investment fraud lawyer. A seasoned investment fraud attorney can help you understand your rights and evaluate your potential claims.
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If you or a loved one have suffered investment losses as a result of a cryptocurrency investment, or any other type of investment fraud or broker negligence, contact the offices of Investment Fraud lawyer Melanie Cherdack for a free consultation. Because she has been in the trenches as a former Wall Street attorney, Melanie Cherdack and her team of experienced attorneys have seen just about every type of investment fraud or investment scam. While almost every investment carries a degree of uncertainty and risk, you may have been unnecessarily exposed to such risk. Former Wall Street securities attorney Melanie S. Cherdack and her team of lawyers represent individual and institutional investors who are unwitting victims of investment fraud and broker negligence. She heads up a group of attorneys who represent investors across the United States. Contact us by filling out our online contact form, or calling 844-635-1609.