The more people are attracted to the benefits of DeFi, the more scammers try to find tricks and vulnerabilities to exploit them. As a decentralized finance platform, DeFi is a system with a different way of working. However, it is also very harsh because there is often no way to recover funds or hold malicious actors accountable, in case users are scammed and damage occurs. Therefore, equipping with the necessary knowledge is a way for us to protect our own pockets
Decentralized finance (DeFi) world is brimming with innovation. Even if you’ve done your own research, DeFi projects keep popping up, and it’s hard to keep up.
Blockchains are decentralized and do not require approval – in other words, they are completely “open”. To use, develop or launch projects on blockchain, we do not need anyone’s permission. While this is a positive and unique property of cryptocurrencies like Bitcoin, it also has negative sides.
In theory, anyone can create projects – whether they’re scams or hype projects, with no way to stop them. But logically, we as a community of users can together define standards to separate projects, breakthrough inventions from scams, or fraudulent projects.
So, what are the aspects you should consider to assess a good DeFi project?
What is the purpose of the project?
This may seem like a question you take for granted, especially if you’re new to DeFi.
While the blockchain platform is full of exciting innovations, the vast majority of crypto assets – are unlikely to be made up of new things! In fact, many new projects just try to attract attention with the DeFi name without any innovation.
So you might ask if this project tried to do something new and innovative? Or are they trying to contribute to the new digital economy with their project? What differentiates the project from its competitors? What is the absolute competitive advantage of the project?
These are very simple and common questions. However, by asking this question, you can immediately eliminate a portion of scammed projects.
Another thing you can consider is the software development process. DeFi has the characteristics of an open source software .
So if you know a little bit about programming, you can learn about their code by yourself. Or simply if the project is interesting enough, maybe someone has checked the development of these applications. This can help you quickly spot bad projects.
In addition, you can also look at the development process to check. Are developers constantly updating new code? Projects can have a lot of high ratings, but this check is still a good way to find out if the developers are really up and running or if they just want to make a quick buck.
Smart Contract Audit
Smart contracts and DeFi projects are often audited. Audits help ensure that code is secure. Although, auditing is an essential step in smart contract development, many developers have implemented their code and skip this step. This can significantly increase the risk of using smart contracts.
Note that auditing is often very expensive. So legitimate projects usually can afford and will pay for the audit. Meanwhile, scam projects usually don’t bother with this step.
So, does this mean that if a project is audited, it is completely safe to use? The answer is no. Because audit is necessary, but no audit activity is synonymous with absolute safety. So always consider the risks when depositing your funds into a smart contract.
Are the founders anonymous?
The crypto world is deeply rooted in the freedom of anonymity (or moniker) created by the Internet. After all, we will most likely never know the identity of Satoshi Nakamoto – the person (or group of people) who created the first cryptocurrencies.
However, development teams with anonymous founders are also a risk that you should consider. If they are a scammer, staying anonymous saves them from taking any responsibility. Although on-chain analytics tools are becoming more and more mature, identifying founders as reputable, their identities tied to the real world is still a differentiating factor. separate.
Be aware, though, that not all projects led by anonymous groups are scams. Because there are many examples of legitimate projects created by anonymous group out there. However, you should still consider anonymity when evaluating a project.
In short, are projects with anonymous founders a scam? The answer is no. However, if the question is: “Is it harder for projects with anonymous founders to be held accountable for bad behavior?”, the answer is: “Yes.”
How to distribute tokens?
When studying a DeFi project, we should also consider them in terms of token economics. One of the ways that scammers can make money is by holding a large number of tokens, trying to increase the price and then dumping them in the market.
What if, 40-50-60% of the circulating supply has sold out on the open market? The token price will drop and lose almost all of its value. While a founder holding a significant amount of tokens is not a cause for concern, they can still lead to problems.
In addition to the allocation, you also need to consider how the tokens are allocated. Is this allocation usually done during an exclusive, insider pre-sale who then promotes the project on social media? Is it an Initial Coin Offering (ICO)? Or, is it a way to sell and list tokens directly on an exchange (IEO), and is the exchange using its own reputation to make sure? Are they distributing tokens through an airdrop and potentially causing selling pressure?
Token distribution models have a lot of aspects to consider. In many cases, it is difficult for the average user to have complete information about how tokens are distributed. But the lack of transparency in the way tokens are distributed can be seen as a sign of danger. In short, if you want a full picture of the project, how tokens are distributed is absolutely essential information.
Signs of a scam “take the money and run away”?
Yield mining (aka liquidity mining) is a way to launch new tokens in DeFi. Many new DeFi projects use this method as it can generate nice metrics that benefit the project. The idea of this approach is that users lock their coins into smart contracts, in return they receive a share of the newly created tokens.
Therefore, this may create an opportunity for some projects to withdraw money from the liquidity pool. Or someone else might use more sophisticated methods, or have a huge unmined token pool.
Also, new altcoins are often listed on automated market makers (AMMs) like Uniswap or Sushiswap first. If the project team is the party that provides a good portion of the liquidity for the market pair on AMM, they can also scrap it and sell the tokens on the market. This often results in the token price returning to near zero. Since the market for the coin has essentially ceased to function, this is often referred to as rug bull – aka “Burn one’s bridges”.
After all, if you want to get into this nascent field of yield mining, or simply use decentralized protocols to trade and buy, you may encounter a lot of scams in DeFi. Hopefully, the above overview guides can help you better detect scam projects and bad guys.