As Decentralized Finance (DeFi) is gaining popularity in the financial world, there are a lot of scammers who are trying to explore new methods to take advantage of this. DeFi is a particularly harsh environment, with few options for recovering cash or holding bad actors responsible. Moreover, the DeFi industry is brimming with new ideas and new projects are emerging day by day.
While the permissionless of blockchains make it possible for anyone to use, develop or launch projects on them, there are also some disadvantages of it. Scammy or deceptive projects may be launched by anybody, and technically, there is nothing to stop them. However, as a community, we can assist each other to detect certain characteristics that distinguish genuine breakthroughs from phony gimmicks.
In today’s article, we will discover how to spot scam projects in DeFi. Let’s get started!
The Purpose Of The Project
While there are a lot of innovative projects in the DeFi space, the majority of projects are just trying to cash in on the DeFi hype without even attempting to innovate.
Therefore, when assessing a project, you will have some questions to ask, such as:
- Is this project new and innovative?
- Are they genuinely trying to contribute to the development of this economy?
- What are the differences between the project and its rivals?
- What is its value proposition?
These questions may sound simple, however, it will help you determine if the project is worth investing in or not.
Activity of Development Team
Since DeFi is inextricably linked to the open-source characteristic, you can be able to see the activity of the project’s development team. Therefore, if you have knowledge about coding, you can take a look at the code of the project. With the open-source characteristic, if the project attracts lots of interest, it’s certain that others will jump in and help as well. This will most likely reveal whether the project is harmful. Moreover, you can also track if the developers update the code on a regular basis or not. Although this statistic may be manipulated, it can still be used to determine whether the developers are serious or just looking for a fast cash.
Smart Contract Audits
Auditing is a term that gets tossed around a lot when it comes to smart contracts and DeFi. The purpose of audits is to ensure that the code is secure. Despite the fact that audits are an important component of smart contract development, many developers launch their code without auditing. The danger of utilizing these contracts might be substantially increased as a result of this.
Audits are usually costly, thus, legitimate projects will normally be able to afford audits, whereas scam projects won’t. However, if a project is audited, it doesn’t mean that it’s completely safe to use. Audits are important, but no audit can ever guarantee complete security. Therefore, you need to keep in mind the dangers of putting money into a smart contract.
Is the Founder’s Identity Verified?
The freedom of anonymity that the Internet may give is deeply ingrained in the crypto realm.
For example, we still don’t know who Satoshi Nakamoto is – the individual (or group) who invented the first cryptocurrency.
There is an additional risk with a team whose the founders are anonymous. It’s highly likely that they won’t be held responsible if they turn out to be scammers. Even while on-chain analysis techniques are becoming more advanced, you will be more confident if the founders’ reputation is connected to their real-world identities.
However, there are still legitimate projects led by anonymous people. Still, you’ll need to consider the identity of the founders when assessing a project.
What Is Its Token Distribution Model?
When studying a DeFi project, token economics is an important factor to consider. Scammers can make money by raising the token price while keeping a large amount of it and then selling it on the open market. Imagine a scenario that 50% of the circulating supply is sold, the token’s price would plummet and lose all of its worth. However, a large founder allocation doesn’t necessarily mean that the project is bad, it just implies that there will possibly be some problems down the road.
Moreover, apart from allocations, you will need raise some questions about the project’s token distribution model, such as:
- Is it done through a private pre-sale open exclusively to insiders who receive a fantastic bargain and then hype the project on social media?
- Is it an Initial Coin Offering (ICO)?
- Is there an Initial Exchange Offering (IEO) in which a crypto exchange stakes its reputation?
- Are they releasing tokens through an airdrop, which will almost certainly result in a lot of sell pressure?
There are a lot of subtleties to consider when it comes to token distribution strategies. In many situations, obtaining this information is challenging, which might be a red signal in and of itself. However, if you want to obtain a whole view of the project, you’ll need this information.
Is It an Exit Scam?
Yield farming (also known as liquidity mining) is a new technique for DeFi tokens to be launched. It is used by many new DeFi projects since it can help the project achieve positive distribution metrics. The concept is that users put their money into smart contracts in exchange for a part of the newly minted tokens. You can probably guess the consequence of this if the project is a scam. They will just take the money deposited in the liquidity pool and run.
Moreover, there are new altcoins listed on automated market makers (AMM) like Uniswap and Sushiswap. If the project team is already providing a significant amount of liquidity for the market pair on the AMM, they may simply remove it and dump the tokens on the market, which makes token price usually drops to zero. This is known as a rug pull since there isn’t much of a market left to sell in.
While there are a lot of ways to help spot a scam project in decentralized finance, those listed above are some of the most common ones for you to utilize. Hopefully, this guide can help you determine which one is legitimate, and which one is a scam.