Decentralized finance (DeFi) is one of the fastest-growing sectors of the crypto industry, with $92 billion worth of crypto assets currently locked in
Decentralized finance (DeFi) is one of the fastest-growing sectors of the crypto industry, with $92 billion worth of crypto assets currently locked in peer-to-peer powered protocols – up 196% over the last year.
This growth can largely be attributed to the many lucrative, high-interest earning opportunities available across DeFi lending and trading platforms. But, of course, with any new crypto trend that draws significant attention and investment, there are always scammers looking for ways to capitalize on it – and you aren’t likely to get a refund for your mistakes.
What is DeFi again?
DeFi protocols are blockchain-based platforms that offer a range of financial services you would typically find in the traditional space, such as:
- Loans.
- Insurance.
- Interest-bearing accounts.
The key difference is, DeFi platforms run entirely using smart contracts rather than having an intermediary like a bank or insurance broker operating in the middle.
Smart contracts are self-executing computer programs that enforce contractual agreements between parties.
In an ideal world, they power valuable non-custodial financial services, like lending protocols and decentralized exchanges. But sometimes they contain bugs or gaping security vulnerabilities that allow attackers, or even errant developers, to drain treasury wallets.
To stay safe, it’s valuable to be able to identify common red flags that indicate a DeFi protocol might, in fact, be a scam or operate on faulty code.
To do this, you don’t have to be able to read smart contract code or understand programming. Free tools, such as Token Sniffer for Ethereum and PooCoin for Binance Smart Chain, run automated audits of token contracts to check if they contain any malicious code for you. While these shouldn’t be relied on entirely, they can be a good starting point for your own due diligence process.
Rug pulls
Rug pulls are so common in DeFi that “getting rugged” has become a common phrase in crypto-speak.
A rug pull is a type of exit scam in which the perpetrators create a new token, launch a liquidity pool for it and pair it with a base token like ether (the native token of Ethereum) or a stablecoin like dai (DAI). A liquidity pool is a large pool of tokens that a protocol uses to fulfill trades, as opposed to an order book system where buyers and sellers list their trade orders and wait to be filled.
The key part of this scam is the creators retain a significant portion of the total supply once the token launches.
If they’ve successfully marketed it to the wider crypto community, investors will begin adding liquidity to the pool to earn a portion of transaction fees charged to traders who use it. Once the amount of liquidity in the pool reaches a certain point, the creators dump all their tokens into the pool and withdraw all the ether, dai or whichever base token was used from the pool. This sends the price of the newly created token to near-zero, leaving investors holding worthless coins while the rug pullers walk away with a tidy profit.
It’s a massive red flag when just a few wallets control nearly half the circulating supply of a token. You can check the token distribution on a blockchain explorer – Etherscan for Ethereum – by clicking on the “Holders” tab of a token contract.
A November 2021 study found that 50% of all token listings on Uniswap are scams, so the odds aren’t in your favor when it comes to investing in relatively unknown projects.
It’s generally safer if the team behind a project is public, or if it’s run by anonymous accounts that have earned a good reputation by launching previously successful, honest projects.
Honeypots
Cryptocurrencies are volatile, meaning prices can fluctuate massively over a given time period. But, if a new coin only goes up and nobody seems to be selling it, it can be a sign that something known as a honeypot scam is going on.
This is where investors are lured in by a token’s ever-increasing price but the only wallet that the smart contract allows to sell is controlled by the scammers.
Squid Game token is a recent example. The DeFi project attracted mainstream media attention due to its alleged association with the popular TV show. It rapidly rose in value shortly after launch, but the media quickly noticed investors were unable to sell any of their tokens. Eventually, the founders dumped their tokens and ran off with millions of dollars worth of binance coin (BNB).
It’s important to note that widespread coverage of a cryptocurrency doesn’t necessarily mean it’s safe. Mainstream media outlets may not have the expertise or time to vet a crypto project, and can often assist in drumming up more hype for scams. In some cases, social media influencers may be paid to promote cryptocurrencies without taking the time to realize they’re a scam – and these influencers don’t always disclose that they’re being paid to talk about a project. A-list celebrities like Floyd Mayweather, DJ Khalid and Kevin Hart have all…
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