The decentralized finance industry attracts a lot of attention among cryptocurrency users. Unfortunately, there are many DeFi scams and shady projects to take into account. Distinguishing between real and fake projects can safeguard one’s portfolio.
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DeFi Scams Are Very Real
Given the vast amounts of money flowing through DeFi projects these days, it is a matter of time until things go awry. Most of the projects in this space are legitimate, yet that doesn’t apply to all platforms. Since its inception, there has been a growing number of DeFi scams and other security incidents to take note of.
When an industry like this gains broader traction, there is always a higher risk of encountering a scam. Everyone wants to make money quickly, and operating a fraudulent project is a concrete way of doing so. It is a harsh and unforgiving industry, as users need to remain focused at all times. Do your research before agreeing to financial commitments.
Decentralized Finance Has No Recourse
Similar to most transactions involving cryptocurrencies, DeFi scams ensure users will not get their money back. Once a transaction is complete, it will remain in that state, as there is no chargeback mechanism. Moreover, there are dozens of DeFi projects launching every week. Statistically speaking, it is only normal that some of them will turn into scams.
The permissionless nature of decentralized finance is both a blessing and a curse. Everyone can create projects and write code on a blockchain. However, technology cannot gauge whether one’s intentions are honest. As such, users need to analyze projects, review code, and make a well-informed decision. That is easier said than done.
Conducting A Basic Analysis
It does not take a degree in programming to determine whether a decentralized finance project is genuine or a future DeFi scam. By conducting the most basic of analysis, it quickly becomes apparent what the team’s intentions are.
Is This New Project Needed?
In the cryptocurrency world, there have been hundreds of copycat projects claiming to improve upon existing concepts. More often than not, these “newcomers” bring nothing new to the table and peter out very quickly. The same idea applies to DeFi: is the project innovative, or is it merely copying code and changing a few names?
Any lack of innovation is often a sign of a potential DeFi scam. It takes a lot of effort to create something new in decentralized finance. That wave of innovation will come eventually, but most of the ideas have been tried and tested already. Copying an existing concept is not sufficient in this industry.
Who Is Running The Show?
What happens behind the scenes of decentralized finance is often a big mystery. Most projects have an anonymous team of developers, which doesn’t instill any confidence. The open-source nature of this technology allows for anyone to put code together. However, there is often a lack of accountability, especially if things go south.
Not all protocols built by anonymous developers will automatically become a scam. The lack of transparency adds an extra layer of risk for investors and speculators to take into account. Everyone is free to disclose as little or as much personal information as they want. When trying to collect people’s money, not revealing anything is automatically a red flag.
It is equally crucial to figure out how active these “teams” are. If not enough coding is happening behind the scenes, the project will likely either die or join the list of DeFi scams. While no one expects new code to be added daily, some weekly activity – particularly for new projects – is an absolute must.
Smart Contracts Audits
Far too often, there are new DeFi projects shipping code to the public without going through a proper audit. Going through a peer review of a project’s code will not automatically prevent hacks or other mishaps from taking place. It does reduce the chances of something going wrong and may lend some credibility to the overall project.
Having an audit conducted is a costly endeavor. This cost is a crucial reason for most new projects to bypass this option altogether. For users, it is best to remain adamant about not touching anything that isn’t audited. It is an extra safety net of sorts, but not an “ultimate metric”.
Token Distribution And Allocation
New DeFi projects have their native tokens, which may have some theoretical value. The way these tokens are distributed will often mean the difference between a legitimate offering and DeFi scams. If the “creator’ holds a significant portion of the tokens, a market dump and subsequent scam are likely to occur.
This extends to how the distribution of remaining tokens occurs. If liquidity mining is an option, the rewards for users cannot be too high. Too many tokens on the market often trigger a price crash. Other projects may opt to sell tokens through an ICO or IEO, although no DeFi solution needs to raise that kind of capital to be successful.
Exit Scam Potential
In theory, every decentralized finance project can lead to an exit scam. The vast majority of DeFi scams in 2020 is due to the initial developer existing after dumping their tokens on the market. Another outcome is how the team may launch liquidity mining pools and then take the funds in that pool for themselves. It is a complicated landscape, but one that carries significant risks.
An exit scam is likely to occur if a DeFi protocol’s asset only trades on AMM platforms. Achieving trust from a reputable exchange is not straightforward. Avoid tokens if they only exist on AMM platforms such as Uniswap and Sushiswap. Once a regular exchange lists them, there is a sense of credibility.
Avoiding DeFi scams requires a lot of effort on behalf of the user. This industry has seen its fair share of exit scams, rug pulls, and security incidents. One may even wonder if it is worth putting any money into decentralized finance at all. Buying and holding Bitcoin is often a more reliable form of securing profits, but it’s also far less exciting.
Taking part in DeFi comes with risks that need to be adequately analyzed. Looking over individual projects will help users make better decisions. Even then, it remains possible that something will go awry sooner or later.
Hopefully, our tips outlined above will help you cull the wheat from the chaff.