Disclaimer: This article is meant to provide general guidance to help protect DeFi users and investors. It’s not an exhaustive list and should not be taken as financial advice. Binance Academy is not responsible for your investment decisions.
Anyone can launch scammy or misleading projects, and there’s nothing there to stop them. Well, technically, not nothing – we, as a community, can help each other identify some common patterns that separate the legitimate innovations from the misleading scrap.
So, what should you be on the lookout for?
What is the purpose of the project?
This may seem like an obvious question to ask, especially if you’re new to the DeFi space.
However, a good majority of crypto assets don’t bring anything new to the table. Sure, there’s extremely exciting innovation as well – that’s why we’re all here after all! But many new projects try to just piggyback on the attention on DeFi without even trying to innovate.
So, one thing you can ask is – does this project try to do something new and innovative? Are they trying to contribute to the new digital economy with their project? How is it different from its competitors? Is there a unique value proposition here?
These are very simple, common-sense questions. But, by asking them, you can already weed out a good portion of scams.
So, if you know a bit about coding, you can go ahead and take a look at the code yourself. The great thing about open-source, though, that if there’s enough interest around the project, others will surely do. This can likely uncover if the project has malicious intentions.
In addition, you can also look at the development activity. Are the developers continually shipping new code? While this metric can be gamed, it can still be a good barometer for finding out whether the developers are for real or if they just want to make a quick buck.
Smart contract audits
Something that gets thrown around a lot with smart contracts and DeFi is auditing. Audits are supposed to make sure that the code is secure. While they are an essential part of smart contract development, many developers deploy their code without any audits. This can greatly increase the risk of using these contracts.
One thing to note here is that audits are expensive. Legitimate projects will typically be able to pay for audits, but scam projects usually won’t bother.
So, does it mean that if a project had an audit, it’s completely safe to use? No. Audits are necessary, but no audit will ever mean total safety. Always be aware of the risks of depositing your funds into a smart contract.
Are the founders anonymous?
However, teams with anonymous founders still pose an additional risk you need to consider. If they turn out to be scammers, there’s a good chance they can’t be held accountable. While on-chain analysis tools are getting more and more sophisticated, it’s still different if the founders have a reputation at stake that’s tied to their real-world identity.
Note that not all projects led by anonymous teams are scams. There are certainly many examples of legitimate projects with anonymous teams out there. Still, you should consider the implications of team anonymity when evaluating projects.
So, in summary, are projects with anonymous founders bad? No. Are projects with anonymous founders more difficult to be held accountable for malicious behavior? Yes.
How are the tokens distributed?
Token economics is a crucial aspect to consider when researching a DeFi project. One of the ways a scammer can make money is inflating the token price while having a huge holding and then dumping it on the market.
Token distribution models have a lot of nuances to consider. In many cases, it’s difficult to even get ahold of this information, which in itself can be a red flag. However, if you’d like to get a full picture of the project, this is absolutely essential information.
How likely is an exit scam?
Yield farming (or liquidity mining) is a new way to launch DeFi tokens. Many new DeFi projects use this distribution method as it can create some favorable distribution metrics for the project. The idea is that users lock their funds into smart contracts and get a portion of the newly minted tokens in return.
You can probably see where this is going. Some projects will just outright take the funds in the liquidity pool. Some will use more sophisticated methods, or have a huge pre-mine.