Abstract
As the public pays more attention to the increasingly prosperous DeFi financial innovation, criminals are also studying how to use this technology to carry out scams.
The nature of DeFi is an open, free, unregulated field, and there is usually no good way to recover funds or hold criminals accountable. However, if you know how to spot a scam, you may be able to reduce your risk of falling for one.
Decentralized Finance (DeFi) is extremely innovative. It seems that new DeFi projects have been launched at a rapid pace, and it is difficult for participants to keep up with the pace. It is even more impossible to practice DYOR (do your own research).
We often talk about the permissionless nature of blockchain, which is actually another special expression of the "publicity" of blockchain. No authorization is required to use, develop or launch the project. Although this is the inherent value of digital currencies such as Bitcoin, it will cause certain negative effects.
Anyone can launch a fraudulent or misleading project without any restrictions or regulations. However, it is not completely impossible to deal with scams. Community members can help each other draw on the power of the group to identify common denominators in scams and distinguish legitimate innovative projects from misleading ones.
So, what are the important things we need to pay attention to?
This question seems simple, especially for beginners in the DeFi field.
However, the vast majority of digital currency assets will not bring any innovation. Although there are indeed some exciting innovative projects worth trying, most new projects just put on the guise of DeFi to attract attention, without any innovation in essence.
Therefore, when evaluating a project, you can think about a question: Is this project innovative and innovative? Can the project team contribute to the digital economy? How do they compare to their competitors? Does the project have a unique value proposition?
These common questions are simple but will help avoid most scams.
Developer activities are also worthy of attention. DeFi is closely intertwined with the open source ethos.
If you know something about coding, you can check the code yourself and screen it carefully. The advantage of open source is openness and honesty. If others are interested in the project, they can review the code themselves to determine whether there are malicious intentions.
In addition, research and development activities are available. Are developers constantly updating the code? Although the code can be faked, it can still be used as a barometer to reflect the motivations of developers, judging whether they are sincerely carrying out research and development work, or whether they just want to make money quickly.
Smart contracts and DeFi must be audited frequently to ensure the security of the code. Although third-party auditing is an important part of smart contract development, many developers can still deploy code without any auditing, resulting in a significant increase in the risk for users using smart contracts.
It should be noted that audit fees are relatively high. Legitimate projects can usually afford audit fees, but fraudulent projects will naturally not cover this expense.
So, does the project passing the audit mean it is absolutely safe? The answer is no. Although auditing is a necessary means, it is not a once-and-for-all solution. One must always be aware of the risks of depositing funds into smart contracts.
The nature of the Internet that supports the free use of anonymity (and pseudonyms) is deeply ingrained in the digital currency world. The true identity of Satoshi Nakamoto, the individual or organization who created the first digital currency, may forever remain a mystery.
Therefore, the risks behind anonymous project teams cannot be underestimated. Even if it turns out to be a gang of crooks, it will be difficult to hold them accountable. The increasingly mature on-chain analysis tools do help to avoid scams, but if the reputation of the founder is closely related to the real-life identity, the reliability of the project can be effectively guaranteed.
Please note that not all projects led by anonymous teams are scams, and many legitimate projects are the work of anonymous teams. However, the important impact of anonymous teams must be considered when assessing project risk.
In summary, should we stay away from all projects with anonymous founders? While one cannot generalize, it will be significantly more difficult to hold anonymous founders accountable for their wrongdoings.
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Token economics is a key factor to consider when studying DeFi projects. One of the illegal ways to make profits is to manipulate the price to increase while holding a large number of tokens, and then sell them in the market.
What will happen if 40%, 50% or even 60% of the circulating supply is sold on the open market? The price of the token will inevitably fall rapidly until it completely reaches zero. While some see no risk in a founding team taking a large share of tokens, this could cause a host of problems.
In addition to distribution, the issuance method of tokens also needs to be considered. Will this project launch an exclusive pre-sale, allowing insider traders to accumulate large amounts of coins in advance, and then promote it on social media? Are you conducting an Initial Coin Offering (ICO)? Is it guaranteed by a digital currency trading platform to carry out an initial trading platform offering (IEO)? Are they releasing tokens through airdrops, likely to generate extreme selling pressure?
The token issuance model needs to consider many details. In many cases, we even have difficulty understanding various information, which in itself is a red flag. This is crucial information if you want to fully understand the project.
Liquidity mining is a new method of launching DeFi tokens. Many new DeFi projects use this distribution method to create some profitable distribution indicators for the project. The core idea is that users lock funds in smart contracts and receive a portion of newly mined tokens in return.
The risks behind it cannot be ignored - some projects directly inject locked funds into liquidity pools. Others use more complex mining methods or conduct pre-mining on a large scale.
In addition, new altcoins are usually first listed on an automated market maker (AMM) system, such as Uniswap or Sushiswap. In the early stages of the project, even if the project team injects extremely strong liquidity into the market trading pairs in the AMM system, the tokens can be withdrawn and sold in the market at any time. This will cause the token price to collapse, falling to almost zero. Retail investors are trapped and there is almost no room for selling the tokens in their hands. This situation is often called "cutting leeks".
Whether you are participating in the booming liquidity mining, or simply doing it with a decentralized protocol When exchanging or trading, you will encounter a wide variety of DeFi scams. I hope these guidelines can help everyone develop a sharp eye and accurately identify malicious projects and criminals.
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