How to Spot Scams in DeFi Projects

Key points to take into consideration to spot scams in DeFi projects.

The past year has been massive for the developing decentralized finance (DeFi) industry, with projects accounting for more than $100 billion in market capitalization and over $55 billion total value locked (TVL) in DeFi protocols.

How to Spot Scam in DeFi Projects?

Unavoidably, the growing DeFi demand has drawn the attention of scammers aiming to make the most of the hype.

Scams in DeFi projects are escalating, and honest participants are getting duped of their hard-earned cash. Not every developer out there is trustworthy, and there is no deficit of fraudulent opportunists happy to take your funds.

As these decentralized platforms provide us with enhanced liberty relating to private key custody, lack of KYC requirements, affordable trading commission, and access to new coins, they are also more susceptible to scams.

It is essential for DeFi users to understand various types of scams and how to recognize red flags before purchasing specific tokens or using certain platforms. So, what should you be watching out for to avoid DeFi scams?

Does the Project’s Objective Make Sense?

Not all unidentified platforms and developers should be considered dubious (Bitcoin started out as one such platform, after all!). However, they should be approached carefully unless more credible sources endorse them.

It is highly likely that cryptocurrency projects without any known founders backing it may turn out to be a scam.

Therefore, ask yourself: is this project attempting to launch a fresh, innovative product or service? Is the project instrumental in the new digital financial ecosystem? What differentiates it from its rivals? What is the project's unique selling point?

These questions may seem basic and simple, but they can help eliminate a considerable percentage of dubious DeFi projects.

Developer activity

Another important factor to look out for is developer activity on the platform.

DeFi is inextricably bound to the principles of open source. If you are familiar with technical details, you should proceed and analyze the code by yourself.

Also, the advantage of an open-source project attracting huge traffic is that other people will undoubtedly check the code. As such, it is easy to identify if the platform has any malicious activity.

Furthermore, you can also scrutinize the developer activity. Is the development team constantly improving the code? Although this metric system can be manipulated, it can still be useful to gauge whether the development team means business or whether they are just there to earn some quick cash.

Smart Contracts Review

Authentic DeFi projects should ensure their smart contracts are audited by a professional to eliminate any bugs. Audits are meant to ensure that the platform is secure for investors or users.

Although audits are a key component of smart contracts, some developers launch their codes without auditing. As such, the risk of corrupting such smart contracts is extremely high.

Notably, auditing smart contracts are pricey, and any trustworthy project should be able to afford audits. Lack of auditing does not mean that, without a doubt, the DeFi project is a scam, but they should be approached cautiously to differentiate between honest projects and scammers.

Also, even though audits are essential, they don't guarantee total safety. Always be aware of the risks associated with lodging your funds into smart contracts in the DeFi space.

Are the Founders Incognito?

The world of cryptocurrencies is filled with mysteries, anonymity, and pseudonymity offered by the internet. Nevertheless, we will probably never know the true identity of Satoshi Nakamoto, the person or team that invented the very first cryptocurrency, Bitcoin.

Projects with unknown creators can be a danger and should be approached cautiously. If they end up being swindlers, there is a good chance they cannot be held responsible.

Although you should consider the consequences of anonymity when analyzing projects, not all projects led by pseudonymous creators are scams. The problem is that such projects are more difficult to hold responsible in case of any malicious act.

How are the Tokens Issued?

Tokenomics are essential when conducting due diligence on a DeFi project. One method fraudsters employ is inflating a token price while having massive holdings, and then releasing it into the market. It is useful to check the token distribution plan and tokenomics of the project.

Yield farming or liquidity mining is a popular way of distributing tokens in the DeFi space. The notion is that users lock their funds using smart contracts to obtain a share of brand-new minted DeFi tokens.

Many exit scams will take the funds locked in liquidity pools outright. Others will employ complicated methods or hold a massive pre-mine.

Is the distribution done through an exclusive advance sale, known only to insiders who then publicize the project on their social media handles? Is the project an initial coin offering? Are the coins being issued through an airdrop which might result in increased selling pressure? If you want to obtain a clear picture of the project, this is crucial information.

Final Thoughts

Genuine DeFi platforms with a well-detailed roadmap should have active social media accounts, interact with the community, and maintain a good reputation. Whether you intend to participate in yield farming, swap tokens, or trade through decentralized exchanges, scammers in the DeFi market are inevitable.

We hope that these standard instructions will help you identify scammers and harmful projects.