With scams at DeFi multiplying every day, industry stakeholders are urging investors to prioritise due diligence before investing in any project.
For those working in the DeFi field, not a day goes by without reporting a project or other „exit scam“ on its investors. From sudden withdrawal of backing to false pre-sales, both DeFi experts and novice traders are bleeding Ether’s (ETH) value into these scams.
With DeFi creating a market segment where the cost of starting a project is almost zero, dishonest players now have the perfect environment to continually siphon off funds from the victims. With the help and complicity of a multitude of social network scammers and the current climate of frantic pursuit of Yield Farming returns, these crypto-scammers are capable of carrying huge sums of money amounting to hundreds of millions of dollars.
Instead of DeFi helping to democratise access to global finance, the emerging market niche is being invaded by scams. The sheer volume of swindles, scams and other unpleasant market practices also appears to have contributed to a significant cooling of prices in the sector, as investors become increasingly wary of new projects.
Crime pays at DeFi
As for the scams, those seen in the DeFi space follow the same basic playbook. The anonymous founders create a new project that copies the code of an intelligent contract from an existing token and make small changes to the parameters such as the total supply.
Typically building on any trends that have recently gained favor in the DeFi marketplace, these scammers flood Telegram groups and other social networking platforms. With the help of the „moon boys“, or paid accomplices with a considerable number of followers on Twitter, the project creators spread the word about their alleged new DeFi „jewel“. All these scams share the same premise: low market capitalization caused by a limited supply of tokens that guarantee huge profits for early adopters or about 1,000% profit.
However, with these projects focused on price and having little or no consideration for useful technology, the zero-sum game results in a sharp drop in valuation that leaves most adopters with bags of ERC-20 tokens worthless. For Douglas Horn, chief architect of the Blockchain Telos network, the success of these scams is based on the unbridled desire to make a quick profit in the crypto market, as he told Cointelegraph:
„Any time you are chasing this kind of FOMO market action, you are already making a mistake because you are betting on your ability to make a profit by being faster than the masses, knowing that it is impossible for all or even most of the participants to make it. That will always end in tears for most participants and is an extremely poor investment strategy. […] Good investments do not have that level of FOMO or time contraction“.
When developers are not immediately withdrawing support, some project developers are adding lines of malicious code designed to steal funds from their users. Yield Farming participants in the dubious UniCats protocol recently saw their balances in tokens diverted by a dishonest developer.
Hidden behind anonymity, project developers and promoters are taking advantage of the credulity of some crypt investors. In some cases, these rogue players choose to use the long-term approach of cultivating a huge following and appearing to be against scams. Once their attraction to social networks reaches a certain level, they announce a pre-sale of tokens from a new income-generating machine. Based on the trust gained by the project’s creators, investors pile up their ETH and the scammers soon disappear with the funds.
Useful tips to avoid DeFi scammers
Amidst the litany of counterfeit coins appearing in decentralised markets such as Uniswap, the need arises to arm investors with useful information to avoid becoming victims. Given the novel nature of the industry, there is still a considerable knowledge gap among investors that makes them easy targets for these cryptic scammers. Malcolm Tan, a board member of the KingSwap automated market-making platform, told Cointelegraph that investors have a responsibility to do their own due diligence:
„It is very important to look at the team and the founders, and check their profiles on LinkedIn and those of their advisors to see that they have actually listed the project. …] Read as much as you can about the projects and make sure you think about how you would get your money back if you put it into the project – which means that projects that don’t even list their location or jurisdiction or have familiar faces to look at if things go wrong, shouldn’t be touched.“
According to Michael Gu, founder of the popular YouTube channel Boxmining, DeFi investors should adopt the „don’t trust, verify“ philosophy. Writing to Cointelegraph, Gu advised high net worth hunters to become experts in researching DeFi projects, adding that anyone can easily check „how much a developer has built in terms of code, to make sure they are not lying or embellishing,“ he added:
„Devoting time to research is key, I personally spend up to six hours a day on research alone. Right now, the best way to avoid scams is to check the facts – which includes looking at the smart contract code and GitHub repositories. This is the best part of DeFi, as the smart contracts are open source and open to everyone to verify and validate.“
Since withdrawals by developers are possible from time to time because the liquidity of the project is not blocked, it has become popular among investors to check whether the developers of a new token have blocked liquidity using services such as Unicrypt. Even with blocked liquidity, malicious code hidden in the contract can also present a back door for dishonest players to drain the funds. For example, in February 2020, hackers were able to exploit a code weakness to execute flash loan attacks on the bZx decentralised loan protocol, resulting in a loss of around 1,139 ETH, worth around 1 million dollars at the time.
Taking the shine off a legitimate niche of crypto currencies
Apart from the significant losses suffered by the victims of these scams, it is reported that the sheer volume of fraudulent activity is taking its toll on the DeFi market as a whole. As in the case of the ICOs, the fake projects are preventing attempts to initiate the democratisation of global finance.
Commenting on the negative impact of these scams, Horn told Cointelegraph that the Blockchain technology should represent transparency and trust, but „instead, it is more prominently associated with these scams and unaudited codes, just as the failure of many ICOs to live up to their promises helped sink cryptosystems in early 2018. According to Horn, the current situation in the DeFi space is escalating even further than what was seen during the ICO craze:
„The DeFi cycles are happening at a much faster pace. All this detracts from the amazing potential of democratised finance to build powerful systems and self-created derivatives from chaining many different financial primitives. Someday this will change the world, but not until there is more stability and quality in the offerings.“
There is an emerging trend in the DeFi space that has seen the market transition from Yield Farming to „Ponzinomics“, with sudden withdrawals by developers and fraudulent pre-sales becoming commonplace in recent weeks. For Gu, these scams threaten to deflate the hype and enthusiasm surrounding the DeFi space:
„These scams are affecting people’s interest in Yield Farming, which is the main attraction for people, as some projects promise unrealistic returns not seen before. And with interest and returns in Yield Farming decreasing due to people’s fear of scams, the corresponding interest in DeFi in general is also losing strength.“
However, not all stakeholders share the view that these DeFi scams are the death knell of the emerging cryptomoney market. Rafael Cosman, co-founder and CEO of stablecoins issuer TrustToken, told Cointelegraph that DeFi’s space can overcome the challenges posed by rogue players:
„All new technology is subject to bad actors who, all too often, are also the first to adopt it. Cutting edge technology has often been an attraction for money-making scams, pornography or the sale of illicit goods, but when good, creative people keep building, technologies like the modern Internet are obtained. […] I predict that DeFi will continue to innovate, consumers will continue to become smarter, and standards will continue to rise for what it calls something worth putting your money into.“