What is a carpet pull?

A scam is a scam where a cryptocurrency or NFT developer hypes up a project to attract investor money, only to suddenly shut down or disappear, taking investor assets with it. The name comes from the idiom “to pull the rug out” from under someone, leaving the victim off balance and scrambling.

Pushbacks have increased as decentralized finance (DeFi) attracts more investors to the crypto space. In the first six weeks of 2023, there were at least 11 withdrawals, resulting in the theft of a combined total of more than $14 million, according to Comparitech’s crypto scam database.

We cover the types of rug pulls, real-life examples and how to prevent yourself from falling for one.

Types of carpet pulling

Mattress covers can be considered hard or soft. A hard-back is when a developer has no intention of ever completing a project and intends to defraud investors from the start, such as “hardwiring” a project’s code to open an avenue too late for theft. In contrast, a soft carpet pull usually lacks code-level cheating. Instead, soft pulls tend to rely on marketing hype to falsely inflate a project’s value, and then the project’s founders shut it down and run off with the money. Regardless, the result of either type is investor losses.

Retreats generally fall into the following categories:

Spillage

This type of soft carpet pull is similar to penny stock pump-and-dump schemes. The developers of a project promote it to attract investors and encourage trading activity, using marketing tools such as social media, sweepstakes and other incentives as well as private servers such as Discord to create a community around the project. After inflating a coin’s or NFT’s value, the developers quickly sell their own stock, which raises the value of the token. Investors are then stuck with mostly worthless assets. Dumping schemes can last hours or years, depending on the developers, and can sometimes look like normal market volatility rather than deliberate scams.

Steal liquidity

Projects hosted on a DeFi trading platform usually require a pool of crypto tokens for trades and loans. These tokens are ostensibly secured with smart contracts, but developers can build loopholes in the contracts that allow them to steal the pool of tokens from their investors. This is considered a hard carpet pull, as the developers created the project with a malicious intent.

Limitation of sell orders

Another example of a hard carpet pull, this scheme relies on a project’s developer including restrictions on selling in their tokens’ code. While investors can continue to buy, they cannot sell unless a developer allows it. Scammers then dump their tokens whenever they want, leaving investors in the lurch and with ultimately worthless assets.

Is carpet pulling illegal?

The short answer: It depends. Crypto fraud regulation is not yet consistent nationally or internationally. In the US, for example, regulation has been unclear, as it is not yet clear what the SEC considers under its purview. For example, the SEC does not consider Bitcoin a security, but it filed a lawsuit against Ripple Labs for selling its XRP digital token. Ripple is fighting the charge, arguing that crypto tokens should not be treated as a security.

If you’re confused, you’re not alone – sorting out what counts as an investment contract (a security) or not is difficult in the crypto space. However, the SEC has a guideline to define what a security is. This is called the Howey test, and states that “an ‘investment contract’ exists when there is the investment of money in a common enterprise with a reasonable expectation that profits may be derived from the efforts of others.” ” Some experts believe that blockchain projects, including initial coin offerings (ICOs), should be treated as securities, while the tokens themselves, such as bitcoins and ether, are not.

While hard carpet pulling is typically illegal, as it is usually clear that the developer has stolen investor funds with no intention of completing the project, soft carpet pulling may not technically be illegal, although highly unethical. Because it can take years to pull a soft carpet, it may seem like the developers are still actively working on the project, and they may be.

However, some states are stepping up efforts to combat crypto-fraud, even for scammers playing the long game. For example, the state of New York proposed a bill that would punish developers who own more than 10 percent of their virtual token supply and sell more than 10 percent of the total supply within a five-year period from the last sale of the tokens.

Famous examples of crypto carpet pulling

Crypto scams are big business, with an estimated $25 billion lost to cryptocurrency and NFT scams to date, and no signs of slowing down. And with more than $2.8 billion lost to rug draws in 2021 and more than 280 rug draws conducted in 2022 alone, there’s no shortage of examples to draw from.

Here are some carpet trends that have stood out over the years.

Thodex

Faruk Fatih Ozer, the founder of Thodex, formerly one of Turkey’s largest crypto exchanges, fled to Albania in 2021 after allegedly defrauding his platform users of $2.7 billion in funds. Before fleeing Turkey, Ozer’s company offered millions of free dogecoins to new registrants, which many users say they never received.

In 2022, Ozer made headlines again when he was arrested in Albania and extradited to Turkey. Turkey’s government has stated that they are seeking a sentence of more than 40,000 years against Thodex’s founders and co-conspirators.

AnubisDAO

In a prime example of a liquidity pooling scheme, AnubisDAO’s anonymous developers defrauded investors of around $60 million. The developers, who had no website or white paper, proposed a decentralized currency backed by a basket of assets. After receiving an outpouring of investor support, the developers drained the AnubisDAO liquidity pool 20 hours after the sale.

Evolved Apes

In the fall of 2021, an anonymous developer known as Evil Ape disappeared after taking $2.7 million in investor funds. Investors fell for a bogus NFT project called Evolved Apes, a collection of 10,000 cartoon monkeys that was supposed to include a fighting game. Although the game was never developed, the NFTs exist and can still be found on OpenSea, an NFT marketplace.

Frosties NFT

Ethan Nguyen and Andre Llacuna made headlines in 2022 when they were charged with conspiracy to commit fraud and money laundering in one of the first safe havens in the US. rewards, gifts and exclusive events. Hours after selling about $1.1 million of Frosties, Nguyen and Llacuna shut down the project and walked away with investor funds.

How to avoid a carpet pull

Most carpets come from new projects that may seem like exciting investments. With widespread fraud in the crypto world, extra due diligence is necessary before investing your money.

While not foolproof, these tips can help you sidestep a scam.

Be skeptical

A healthy dose of skepticism is helpful when sorting through crypto hype. Not every new cryptocurrency or NFT will be the next big thing. In fact, most of them won’t, as demonstrated by money pooled into the most popular cryptocurrencies. Bitcoin and Ethereum still dominate the market, with the third largest coin not even half of Ethereum’s market cap.

As many crypto experts say, don’t invest money you can’t afford to lose.

Be patient

One of the tried-and-true ways scammers drive sales is by creating a sense of urgency or scarcity. In other words, fear of missing out, or FOMO. If you feel that this is an opportunity that you absolutely cannot pass up and that you must invest immediately – before you have time to research – take a time out. It is probably wise to take a step back and determine what is creating the feeling. Is there a legitimate time script or is it a manufactured nutritional craze?

Unlike some other industries, crypto does not have a built-in cooling-off period, which means that in most cases you cannot cancel or withdraw a fund transfer. Taking your time may mean you miss out on an opportunity every now and then, but it can save you even more.

Research

The crypto world is full of anonymity and aliases, which is part of the reason fraud is so common in the space. However, you should still gather as much information about the project as you can. This can include the developers’ backgrounds, including previous projects and experience. For those with coding and blockchain experience, check out the project specs. And if the project has a white paper, you’ll want to read it.

Read disclosures

If the investment opportunity comes with disclosures, you should read them. The SEC has fined crypto companies for not providing the necessary information to investors and potential investors. The regulator stated that if crypto companies offer investment contracts (ie, securities) in exchange for tokens, they must register and comply with SEC regulations.

“We are not concerned about the labels placed on offerings, but about the economic realities of them,” said Gurbir S. Grewal, director of the SEC’s Division of Enforcement. “And part of that reality is that crypto-assets are not exempt from the federal securities laws.”

Beware if a digital asset offering lacks a disclosure but appears to fit the description of a security.

Bottom line

Before you invest, make sure you do your due diligence. While you’re not guaranteed to catch every scam, you’ll have a much better chance of avoiding bad deals if you take your time and do your research. If you’re putting your hard-earned money into a risky crypto project, it’s essential to understand what you’re buying and why you think it will go up in price.