For those involved in decentralized finance, hardly a day goes by without a report of one project or another “exit scam” popping up among its investors. From scams to fake presales, DeFi experts and novice traders alike are bleeding precious Ether (ETH) through these scams.
Because DeFi has created a market segment where project initiation costs are close to zero, fraudulent actors now have the perfect environment to continuously siphon funds from victims. Aided and abetted by a horde of social media gangsters and the current climate of frantic profit-hunting, these crypto scammers are capable of hoisting huge sums of money, amounting to hundreds of millions of dollars.
Instead of DeFi helping to democratize access to global finance, the EM niche is being swamped with scams. The sheer volume of scams, rip-offs, and other unsavory market practices also appear to have contributed to a noticeable price slowdown in the industry as investors become increasingly wary of new projects.
Crime pays in DeFi
As for the scams in the DeFi space, they follow the same basic principle. Anonymous founders create a new project, usually copied from the existing token contract code, and make minor changes to parameters such as the overall offering.
Typically, these scammers capitalize on the trend that has recently won the favor of the DeFi market, flooding Telegram groups and other social media platforms. Project developers are spreading word of mouth about their supposed new DeFi “gem” with the help of “moon boys” or paid shills with sizeable Twitter followings. All of these scams share the same premise: a low market cap due to a limited supply of tokens, guaranteeing huge returns or profits of around 1,000% for the early adopters.
However, as these projects focus on price and have little or no regard for useful technologies, the zero-sum game results in a precipitous decline in valuations, leaving most adopters with sacks of worthless ERC-20 tokens. For Douglas Horn, chief architect of the Telos blockchain network, the success of these scams stems from the unbridled desire for quick profits in the crypto market, as he told Cointelegraph:
“Any time you chase this type of FOMO market action, you are already making a mistake because you are betting on your ability to make profits by being faster than the crowd, even though you know that this is for everyone or even the impossible for most participants to pull this off. This will always end in tears for most participants and is an extremely bad investment strategy. […] With good investments, there isn’t as much FOMO or time pressure.”
Some project developers, when not pirating, add lines of malicious code aimed at stealing funds from their users. Yield farmers using the dubious UniCats protocol recently saw their entire token balance drained by a fraudulent developer.
Project developers and promoters hide behind anonymity and take advantage of the gullibility of some crypto investors. In some cases, these renegade actors opt for the long-term approach of building a large following and appearing to be opposed to scams. Once their social media appeal reaches a certain level, they advertise a token pre-sale for a new revenue-generating machine. Due to the trust gained by the project developers, investors are pouring in with their ETH and the scammers soon disappear with the funds.
Useful tips to avoid DeFi scammers
Amidst the litany of fake coins being listed on decentralized marketplaces like Uniswap, there is a need to arm investors with useful information to avoid becoming a victim. Given the newness of the sector, there is still a significant knowledge gap among investors, making them easy targets for these crypto scammers. Malcolm Tan, board member at automated market-making platform KingSwap, told Cointelegraph that it’s up to investors to do their own due diligence:
“It’s very important to look at the team and the founders and to check their LinkedIn profiles and those of their consultants to see that they actually listed the project in question. […] Read as much as you can about the projects and think about how you would get your money back if you put it into the project – that is, the projects don’t even state their location or responsibilities, and no familiar faces either have to look for should not be touched when things go wrong.”
According to Michael Gu, founder of the popular crypto YouTube channel Boxmining, DeFi investors must adopt the “don’t trust, verify” philosophy. Writing to Cointelegraph, Gu advised yield-hunters to become familiar with researching DeFi projects, adding that anyone can easily check “how much code a developer has built to ensure they are not lying or glossing over.” ‘ and added:
“Taking the time to research is crucial. Personally, I spend up to six hours a day just doing research. The best way to avoid scams right now is to fact check, which includes looking at the smart contract code and GitHub repositories. This is the best thing about DeFi because smart contracts are open source and can be verified and validated by anyone.”
With rug pulls possible due to unlocked project liquidity, it has become popular for investors to use services like Unicrypt to check if the developers of a new token have locked liquidity. Even with locked liquidity, malicious code hidden in the contract can also provide a backdoor for fraudulent actors to siphon funds. For example, in February 2020, hackers were able to exploit a code weakness to perform flash loan attacks on the bZx decentralized lending protocol, resulting in a loss of around 1,139 ETH, which was worth around $1 million at the time.
Taking the shine off a legit crypto niche
Aside from the significant losses incurred by victims of these scams, the sheer volume of fraudulent activity is reportedly taking its toll on the DeFi market as a whole. As with the initial coin offerings, fake projects are hampering attempts to advance the democratization of global finance.
Commenting on the negative impact of these scams, Horn told Cointelegraph that blockchain should represent transparency and trust, but “instead, it’s mostly associated with these scams and unverified code, as well as the failure of many ICOs to deliver on their promises to their downfall.” Crypto in early 2018.” According to Horn, the current situation in the DeFi space is escalating even more than during the ICO boom:
“DeFi cycles are much faster. All of this detracts from the amazing potential of democratized finance to build powerful systems and homegrown derivatives from the concatenation of many different financial primitives. One day this will change the world, but only when the offers are more stable and of higher quality.”
A trend is emerging in the DeFi space that has shifted the market from yield farming to “ponzinomics,” with bootlegging and fraudulent pre-sales becoming commonplace in recent weeks. For Gu, these scams threaten to dampen the hype and buzz surrounding the DeFi space:
“These scams are hurting people’s interest in yield farming, which is the main draw for people, as some farms promised unrealistically high yields that never existed before. And as interest and returns in yield farming fall due to people’s fears of fraud, corresponding interest in DeFi in general also loses momentum.”
However, not everyone involved agrees that these DeFi scams are the death knell for the nascent crypto market. Rafael Cosman, co-founder and CEO of stablecoin issuer TrustToken told Cointelegraph that the DeFi space can address the challenges posed by fraudulent actors:
“Any new technology is subject to bad actors, who too often are early adopters. Edge technology has often been a magnet for fraud, pornography, or the sale of illegal goods—but when good, creative people innovate, technologies like the modern internet are born. […] I expect DeFi will continue to innovate, consumers will become smarter, and the standards of what’s worth investing in will continue to rise.”
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