“Rug pulls” are a calamitous event that can happen in crypto markets, as shady projects with anonymous, NFT avatars run away with crypto investors’ money.
A rug pull is a type of financial scam, similar to a pump-and-dump.
To start, someone lists a coin or token on unregulated Decentralized Exchanges (DEXs). When listing, the fraudster pairs the coin with a popular crypto, commonly Ethereum. The pairing is important, but we’ll get more into that later.
After listing, the crypto gets promoted on social media, pointing unsuspecting investors to an innocent-looking coin.
How Rug Pulls Work
Rug pulls work on decentralized exchanges where users can create their own liquidity pool. Liquidity pools are created when a Liquidity Provider provides an equal dollar amount of two coins that then get used simultaneously for enabling swaps between those cryptos and keep the relationship between the prices of the two coins stable.
So in the case of rug pulls, the fraudster will create a “pairing” between their illegitimate project and a legitimate one. To make the coin accessible to many, it typically will get paired with Ethereum.
To understand how this works, it’s important to know how prices are calculated on a DEX. Prices are calculated based on the following formula: x * y = k, where k is a constant.
If I made a liquidity pool with 50 tomatoes and 50 potatoes, each worth $1 at the start, then our constant “k” will…
