The “red flags” to see before investing in a DeFi project.
According to data from Statista, there are currently more than 82 billion dollars secured in DeFi protocols. However, the market is in decline.
While users of these protocols have grown by 300,000 since the beginning of 2022, that represents less than half the increase over the same period in 2021. The size of the decentralized finance (DeFi) market in early 2021, measured by the number of locked cryptocurrencies decreased by more than $25 billion since August of last year. The possible causes are significant changes in the price of almost 100 cryptocurrencies in the ecosystem that could have led investors to withdraw. Another factor is the rising gas prices (transaction fees) of Ethereum, the main cryptocurrency in use within DeFi.
Another reason is the number of swindles and rug pulls that happen in a highly unregulated environment. According to a report by London-based Elliptic, more than $10 billion in user funds got stolen in cases of fraud and theft in DeFi products during 2021. This represents a 700% increase from the previous period. This happens, in part, due to the very nature of technology; for example, being non-permissioned. These Blockchains are usually public and anyone can build solutions on them.
How to Avoid Scams and Scams in DeFi
One of the first and easiest steps is to do a sanity check on the project. Ask yourself questions such as, what kind of project is it, what are its fundamentals? What is the value proposition or innovative technology and how does it differ from its competitors? Are the returns it promises realistic with what the market pays?
Similarly, it is advisable to seek in-depth advice on other qualitative aspects of the project. How is the activity of the project in the technological field? Do you know of any improvements and daily changes to the project? In the same way, how does the distribution of tokens happens? How much remains in the hands of the founders? Is the distribution system a pre-sale, an ICO, or an IEO?
Different Technologies Targeted towards the Same Solution
To help solve these issues there are different technologies. For example, through the Dextools tool, you can analyze transactions on the Ethereum and Binance Smart Chain Blockchains. Thus, you can see all the purchases and sales that are taking place for a token. If a considerable volume of sales does not appear, it may be a token that has no movement in the market and therefore it will be very difficult to sell.
Similarly, using Unicrypt you can quickly check the liquidity status of a specific token. If you lock the token creator’s initial liquidity, then they cannot withdraw the funds and a rug pull could occur. Another similar tool is the block explorers, which allow you to see all the information about a token. You can get reliable data about the liquidity pool, full transaction data, token contract code, token creator address, and more.
Another of the most popular and complete solutions is Token Sniffer, a tool used to search tokens in both Ethereum and Binance Smart Chain. By providing the address of the token contract in the search bar, the solution offers information about vulnerabilities, a brief audit of the contract, and more. Another useful feature is the list of known swindles and hacks, which allows you to check a suspicious token against a database of known frauds.
By Audy Castaneda
