Ah yes… the question that plagues every DeFi trader: How do I know if this project is a scam or not?
In November this year, DeFi total value locked reached an all-time high of $276.92B. DeFi is flourishing and numerous projects are sprouting out every week. All crypto investors know that getting into the game early could earn you extremely high gains. But what parameters should you use to evaluate a project?
Read on for 5 tips (and bonus ones!) to identify legitimate projects and avoid scam ones.
1. Check Their Website And Social Media
You can start small - visiting the project’s official channels. Scam projects may set up a website to appear legitimate, but they are often ‘low-effort’. They may have multiple pages stating “Work in progress” or have incorrect elements on the page. Check if they have an active Support Centre with regular updates on tutorials, FAQs and announcements from the project.
The same goes for their social media. If posts are only calling for pumps and there are no efforts to engage the community e.g. Educational content, Community Features, Polls & Feedback, you should be curious why.
Bonus tip: Be wary of people impersonating project moderators in community groups like Telegram. Don’t let your guard down.
2. Make Time to Research the Project
Some DeFi projects truly want to solve existing problems, such as aiding the wider transition from CeFi to DeFi, managing scalability issues, promoting cross-chains and more. Others do not have as much utility.
Take time to research about the project and the team. Refer to established listing sites like CoinMarketCap and CoinGecko to check if the project is listed. Ask yourself: What problems are they trying to solve? What new innovations are they introducing into crypto? What is their unique value proposition? Do they have strong technology behind the project?
Another factor that many people consider is the origins of the founding team. Having the founding team doxxed is reassuring to many investors. If this is important to you, it’s up to your own discretion whether to invest in a project whose founders are doxxed, or not.
Bonus tip: With the increasing shift to DEX, more products are available decentralized. This means no intermediaries and you own your own keys. If you want to have more autonomy, I say start investing decentralized.
3. Look At Who’s Holding And Trading
Every DeFi project with its own token should have tokenomics published. Before you invest, you should understand the token distribution and use cases.
Consider tracking token holders and trading activity. You can make use of tools like Dextools (available for use with Binance Smart Chain and Ethereum). If you see no sell activity or very low sell activity, it is probably a scam. Beware of high trading frequency from the same addresses too. The project owners could have manipulated the code so that you are unable to sell the token after buying. They might also whitelist only certain addresses so that the token seems to be trading normally.
Example screenshot of trading activity on Dextools
Another useful tool is a block explorer like BscScan or EtherScan. Note that these are blockchain specific. Block explorers contain all information about token contracts, token creator addresses, all transactions regarding the token and more. You can even check whether liquidity has been removed from the pool.
Example screenshot of token information on BscScan
4. If It’s Too Good To Be True…
As the popular saying goes: "There ain't no such thing as a free lunch". Scams often promise you double or triple the gains. They may ask you to send crypto to an address and direct you to an event page with an unfamiliar domain name (red flag!). Some scam events may also claim to be from an established project and may even set up “Customer Service” chatbots. What can I say, they are becoming more sophisticated.
As a rule of thumb, always check that the event page is using the same domain name. You should also visit the project’s channels to double confirm on ongoing events.
Bonus tip: Ever noticed free airdrop transactions into your wallet? Do a simple Google search to check if you’ve been targeted by scam projects (most probably so). Do not interact with them.
5. Audits Help… But Code Can Still Be Compromised
Many DeFi projects use smart contracts to interact with the blockchain or an asset. Smart contract audits closely examine a smart contract’s code for bugs and vulnerabilities. They also suggest improvements and solutions to fortify the code.
In general, scam projects would not invest the time and money to conduct an audit. They focus on pumping and would hide intentional manipulation of the contract. But let’s be real: The above only holds true in a perfect world. As scams evolve, who’s to say that they wouldn’t go through basic audits to gain investor confidence? The vast majority of investors would probably accept audit claims at face value anyway.
What’s more, whether big or small, projects that have undergone security audits can still experience hacks. Some prominent examples include cross-chain DeFi platform Poly Network’s $600M hack, DeFi yield protocol BadgerDAO’s $120M hack and recently, yet another $30M hack at DeFi yield platform Grim Finance.
All things considered, this author personally feels that smart contract audits are good but do not guarantee safety of funds. Projects should undergo regular audits to update their code, and you should keep your eyes peeled and make use of the other tips mentioned in this article.
The views expressed in this article are the author's alone and do not necessarily represent the views of ApolloX.
Risk Reminder: Crypto trading carries a risk. All trading activities are done at your discretion and at your own risk. The information here should not be regarded as financial or investment advice from ApolloX. ApolloX will not be liable for any loss that might arise from your use of any financial product.
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