Because of the lack of regulations on cryptocurrency and the fact that it's decentralized, scams are exceedingly common. Losses from scams reached $7.8 billion in 2021, and cryptocurrency exit scams made up more than one-third of the total. If you invest in cryptocurrency, and especially if you like to buy into smaller projects, understanding this type of scam is a must.
What is a cryptocurrency exit scam?
A cryptocurrency exit scam is when the developers of a cryptocurrency pull their funds and abandon the project to profit from investors.
An exit scam can occur before, during, or after a cryptocurrency is launched. It starts with the developers heavily marketing the project to attract investors. This often includes promises of huge profits, posts across social media, and hiring influencers to promote the cryptocurrency.
Once people have invested, the developers take the money and disappear. The value of the cryptocurrency plummets since it's revealed to be a scam, and people who invested lose all their money.
In addition to the developers, there can be other parties involved in cryptocurrency exit scams. Promoters and possibly even early investors could be in on the scheme. Because cryptocurrency transactions are tied to wallet addresses and not to anyone's identity, it's simple enough for scammers to remain anonymous.
Cryptocurrency exit scams explained
Cryptocurrency exit scams take advantage of the hype surrounding digital currencies. Most people have heard about the kind of returns Bitcoin (CRYPTO:BTC) and other successful cryptocurrencies have generated. Scammers prey on hopes by hyping up their cryptocurrencies as the next ones that will skyrocket in price.
This type of scam has gotten more popular over the years, in large part because it's become so much easier to launch crypto tokens. Anyone who wants their own cryptocurrency can create one themselves with a little technical knowledge or hire a freelancer to do it for less than $100.
The way cryptocurrencies work makes exit scams a natural fit. Scammers can quickly create cryptocurrencies and remain anonymous. The crypto market attracts lots of people hoping to get rich quickly, so it's just a matter of appealing to their fear of missing out on the next big thing.
How a cryptocurrency exit scam works
The early cryptocurrency exit scams typically used initial coin offerings (ICOs), meaning when a company sells a new cryptocurrency for fundraising purposes. The scams gained popularity during the ICO boom in 2017.
It works exactly how you'd expect. A group comes up with an exciting new cryptocurrency project and builds a following for it. They announce an ICO, where investors will get the opportunity to buy the cryptocurrency before anyone else. After the ICO ends, the group disappears with the money. And, since ICOs normally require payment in cryptocurrency, those payments are irreversible.
Another well-known type of exit scam has been darknet vendors disappearing without delivering illicit goods that had been paid for with crypto. Then there’s the rug pull, which is popular in the world of decentralized finance (DeFi). Rug pulls sometimes occur on centralized exchanges but are much more common on decentralized crypto exchanges where anyone can add new tokens for trading without going through any type of audit or verification.
In a common type of rug pull, developers launch a crypto token and list it on a decentralized exchange. This allows investors to trade for the new crypto token. Once the price of that cryptocurrency has gone up enough, the developers trade all of their tokens at a profit.
Cryptocurrency exit scam red flags
Here are the most common red flags indicating a cryptocurrency exit scam:
- No recent independent code audit: Although having a code audit performed doesn't guarantee there won't be a rug pull, good crypto projects publish evidence of having had an independent code audit since they can find weaknesses that could allow rug pulls to occur.
- Anonymous developers: If the team behind a cryptocurrency is anonymous or pseudonymous, there's nothing to stop them from disappearing after a scam and facing zero consequences. It's also impossible to evaluate a team's credibility if you don't know their identity.
- Extravagant claims: Scammers rely on hype to pump up the value of their projects. Watch out for cryptocurrencies with unrealistic goals or that focus on how much money investors will make.
- Aggressive marketing: Exit scams apply a heavy dose of marketing, which often includes YouTube videos and posts on online forums such as Reddit. There's nothing wrong with promoting a cryptocurrency, but if it's a full-on marketing blitz, it's worth questioning why that's such a focus instead of developing the project.
- Website/white paper issues: Scammers often focus on marketing and do the bare minimum everywhere else, such as the project's website and white paper. If anything is poorly written or has an unprofessional design, that's a sign of a potential scam. (Some projects don’t even bother with a white paper -- a big red flag.)
- Uneven token distribution: A cryptocurrency's developers may keep some tokens. But if they control a large portion of the total supply, there's the risk of a rug pull.
If a cryptocurrency has one of these red flags, it's not a guarantee the project is a scam, but you should do plenty of research before you consider investing. If a cryptocurrency checks multiple boxes on that list, odds are it's either a scam or a lousy project.
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Cryptocurrency exit scam examples
There have been many cryptocurrency exit scams over the years. Here are a few examples, including disappearing acts after ICOs and one big-time rug pull:
- Confido was a crypto start-up claiming to develop smart contracts. The Confido team held an ICO in 2017, raised nearly $375,000, and then disappeared.
- PlexCoin was a cryptocurrency that the founders claimed would generate a 1,354% profit in 29 days (a great example of a massive red flag). Its 2017 ICO conned investors out of more than $8 million before being halted by the SEC, which charged the founders with fraud.
- Squid Game (CRYPTO:SQUID) is a crypto token named after the hit show on Netflix (NASDAQ:NFLX). It turned out to be a rug pull since the developers dumped their tokens for $11.9 million.
For anyone who likes to invest in smaller crypto tokens and new projects, it's crucial to be able to spot exit scams. Outside of Bitcoin, Ethereum (CRYPTO:ETH), and the other market leaders, the crypto market is a minefield. There are some diamonds in the rough, but there are also tons of cryptocurrencies designed to separate people from their money. Fortunately, once you know the red flags, it's usually not hard to spot them.