TL;DR
Scammers are constantly finding new ways to take advantage of people, particularly as people become more interested in the exciting financial developments provided by DeFi.
The world of DeFi is widely challenging, and there are few options to recover funds or punish those responsible. However, if you are aware of potential warning indicators, you can reduce your chances of falling for a scam.
Introduction
Decentralized finance (DeFi) is an ongoing debate right now. Every minute, it seems, a new DeFi project emerges, making it difficult to keep track of them all, let alone DYOR.
People frequently use the term “permissionless” to describe blockchains, which is just a fancy way of saying “public,” because anyone may use, alter, and build on them. Although this is an important component of cryptocurrencies such as Bitcoin, it does have some drawbacks.
There is presently no mechanism to prevent fraud or illegal projects from forming. Technically, we don’t have anything to lose because we can collaborate to identify patterns that help us distinguish between actual benefits and a waste of time.
What exactly should you be looking out for?
What is The Purpose of The Project?
Even if you’re not new to the DeFi scene, you might be thinking this.
However, most crypto products do not offer anything novel. There’s also a lot of exciting growth, which is why we’re all here. However, many other companies try to cash in on DeFi’s success without offering anything truly novel.
One thing to consider is whether or not the project is attempting to achieve something novel. Do they believe their job will benefit the emerging digital economy? What makes it stand out from the competition? Is there anything unique about this deal?
These are simple, everyday inquiries. However, simply asking can remove many potential disadvantages.
Making Developmental and Progress
Another measure to consider is developer participation. Open-source values support DeFi.
So, if you know how to write, you can examine the code yourself. The beauty of open-source is that if enough people are interested in a project, someone else will almost certainly complete it. If the notion is poor, this could indicate that it is.
You may also see how we’re doing in terms of development. Do the developers add new code on a frequent basis? Even if it is possible to manipulate this number, it is still a good indicator of whether or not the developers are genuine.
An Analysis of the Smart Contract
Smart contracts and DeFi are both subject to auditing. The purpose of an audit is to ensure that the code is secure. Despite the fact that audits are a key element of smart contract development, many writers send out code without running it. As a result, using these types of contracts might be extremely dangerous.
Keep in mind that audits can be highly costly. Audits are something that most fraudulent projects cannot afford, but reputable projects can.
Is it safe to assume that a project that has completed a review is totally secure? No. Audits are necessary, but they can never guarantee that everything is secure. Before investing in a smart contract, you should constantly consider what could go wrong.
Who is the founder, if anyone?
Online privacy and fictitious identities are crucial to the cryptography community. After all, we’re unlikely to ever learn who Satoshi Nakamoto, the unknown creator of the first cryptocurrency, was.
However, you should be aware of another risk associated with associations whose owners do not want their identities revealed. If they are scammers, they are unlikely to face charges. Even though on-chain analytics are improving all the time, the stakes are higher when the leaders’ real names are at stake.
Keep in mind that not all projects handled by faceless teams are fraudulent. Several reputable projects have utilized secret teams with remarkable success. However, while reviewing projects, it is critical to consider how the privacy of the team may affect the outcome.
Are projects that start with leaders who don’t share their names bound to fail? No. Is it more difficult to hold projects accountable for unethical behaviour if their creators are unknown? Yes.
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How are Tokens Distributed?
When working on a DeFi project, it is critical to research token economics. Scammers can make a lot of money by increasing the token price while holding a huge supply and then selling it all at once.
What would happen if, say, 40%, 50%, or 60% of the circulating supply was sold on the open market? The token’s value decreases, removing nearly all of its value. A big founder’s commitment is not always cause for concern, but it can generate problems in the long run.
In addition to allocations, token distribution is a crucial consideration. Is there a special pre-sale for a select set of people who get an excellent deal and then promote the product on social media? Is this an initial coin offering (ICO)? Is this an Initial Exchange Offering (IEO) that puts a Bitcoin trading platform’s legitimacy at risk? Are they airdropping tokens, which would put a lot of pressure on the market?
There are different aspects to creating token distribution models. The difficulty in obtaining this information should serve as a warning in and of itself. This information, however, is critical if you want a thorough view of the project.
Is It Possible that an Exit Scam Will Occur?
DeFi coin sales now include a yield farming (or liquidity mining) option. Many new DeFi projects adopt this distribution technique since it can result in excellent distribution metrics for the project. Investors securing their money in smart contracts in exchange for a portion of the newly produced tokens is one such use case.
You can probably predict where I’m going with this. Certain efforts may simply take resources from the liquidity pool. There will be individuals who use more advanced strategies or have a significant pre-mine.
Furthermore, automated market makers (AMM) such as Uniswap and Sushiswap are often the first to provide new alternative cryptocurrencies. If the project team was supplying a considerable level of liquidity for the market pair on the AMM, it would be simple for them to sell their tokens on the market. As a result, the value of a token frequently falls close to zero. A rug pull occurs when a product or service no longer has a potential market.
Final Thoughts
There are many DeFi scams out there, whether you want to join in the wild west of yield farming or simply use decentralized protocols to swap and trade. These fundamental criteria should help identify harmful efforts and bad actors.
Do you have any questions about the DeFi market or exit scams? Check out Ask Academy, our question-and-answer platform, where members of the Binance community will assist you.