Whether you’re trading, investing in a project, or learning something new, research plays a vital role for any DeFi user. The DeFi space is competitive and moves swiftly, so due diligence is an excellent way to give you the upper-hand to find projects more quickly and make money on the latest, most innovative protocols. Unfortunately, not all “developers” can be trusted, and there’s no shortage of fraudsters willing to take your money and run. The darker side of finance has always had shysters and charlatans, and crypto’s no different.
DeFi’s infancy means there aren’t yet many safety nets for average users. Typically, scammers take advantage of well-intentioned investors who have no means of recourse. We call this a “rug pull”: when fraudulent projects take money with no intent to deliver a product and disappear once they’ve raised as much as they can. Sometimes the rug gets pulled fast, sometimes it’s slow, but in both scenarios the user gets left with heavy bags of useless tokens and a substantial loss of funds.
The dynamic behind this isn’t very complicated: people want to find groundbreaking projects that garner huge gains, and fraudsters exploit their eagerness. This pattern repeats ad infinitum because almost every DeFi project requires funding, so it makes sense to ask for resources. Some of 2020’s biggest DeFi successes were funded by average users, and that’s one of the exciting things about DeFi, but never underestimate the lengths to which conmen will go to get your hard-earned cash.
It goes without saying that we don’t advocate for you to invest in any unvetted DeFi projects: it’s an enormous risk compared to the reward. However, it’s good to know some of the biggest red flags when researching projects. Here are some reliable indicators that you’re looking at a scam.
1. An anonymous and inexperienced team
Anonymity is a big part of decentralized finance, and there are legitimate reasons for it: regulations are unclear, developers don’t want their private life invaded, and creators don’t want their public persona to hamper the success of a decentralized project that should be controlled by its community. On the other hand, an anonymous team with no credibility or experience sets off alarm bells. “Doxing”, or revealing someone’s identity, is very difficult without trails to follow, so once the money is stolen there’s not much to be done. Anonymity isn’t innately bad, particularly if the developer has a proven track record and credentials from other projects. Beware, however, of developers who are anonymous and can’t produce evidence of previous work.
2. Over-promising and under-delivering
If a project tries to sell you something that seems too good to be true, it likely is. Rare exceptions exist, but the majority of projects that make ludicrous claims about being the next biggest thing in DeFi probably aren’t. Convinced, capable developers understand the value of their product and that the code speaks for itself. Furthermore, if a project makes huge promises but can’t show any evidence of code via a smart contract or on GitHub (the most common tool for developers to share their code), it’s quite possible they don’t have anything at all.
3. Capitalizing on others’ success
We’ve discussed previously how success begets imitation in DeFi. Both developers and investors often attempt to repeat the achievements of leading protocols. When one thing succeeds, it is usually followed by a swarm of clones and a legion of users who feel they missed out on the first one. Although some are successful, most die quickly once traders see the price spiral. Likewise, it’s common for scammers to simply fork the original protocol, promise huge gains, collect funding, and disappear.
4. Avoiding relevant questions
A legitimate team of developers won’t dodge relevant questions from its community. They’ll have an earnest, sophisticated answer for any FUD (“Fear, Uncertainty, and Doubt”) that may arise. Whether it’s about their previous work, intentions, or code, a committed team understands that a community drives success, and they’ll be receptive to criticism and tough questions. If there’s a red flag overshadowing the project that doesn’t seem to go away, there’s probably a reason. Developers won’t be able to answer all FUD (especially when it’s orchestrated by those gunning for a lower price), but look out for projects that censor or ban those asking reasonable questions.
5. Pushing too hard for funding
We’ve spoken about how important funding is for DeFi projects. Developers usually can’t fund a project on their own without the support of outside parties, so they rely on the community to provide funds for liquidity, development and marketing. It’s a win-win situation in a perfect world, but a major warning sign is when developers barrage their community with demands for money. A small-scale, respectable project understands that liquidity will come eventually and will be content with a modest initial raise. Fraudulent projects often push very hard for funding early on without any proof of commitment or work.
DeFi is a fast-paced, exciting space to follow, and things are just getting started. However, it’s always good to have an understanding of what to look for in new projects, of which there’s no shortage. With these tips, we hope you’ll be able to navigate the DeFi waters better and find the true gems out there.