DeFi, which stands for "Decentralized Finance," has two main pillars: stablecoins represented by Bitcoin and Ethereum, and smart contracts that enable trading, borrowing, and investing. The nature of DeFi is an open and unregulated space, typically with no good way to recover funds or hold wrongdoers accountable. We can greatly reduce the risk of being defrauded by learning to identify scams.
For the vast majority of digital asset projects, there may not be any innovation involved. Therefore, when evaluating a project, one can consider whether it brings new ideas and is innovative. Does it have an edge over its competitors? Does the project contain a unique value proposition? These questions are simple but can help differentiate legitimate projects from scams.
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Coders have an inherent advantage in evaluating projects' validity. If others are interested in the project, they can review the code themselves to determine whether there are any malicious intentions.
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In addition, you can also study the project's development activities. Are the developers constantly updating the code? Although the code can be faked, it can still reflect the developer's intentions, which can be used to judge whether they are truly committed to research and development work or just trying to raise money quickly.
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Smart contracts and DeFi must be audited regularly to ensure the security of the code. Although third-party auditing is an important part of smart contract development, many developers still deploy code without any auditing, leading to a significant increase in the risks of using smart contracts for users.
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It should be noted that auditing fees are relatively expensive. Legitimate projects usually have the ability to bear auditing costs, but fraudulent projects naturally will not pay for this expense. However, passing an audit does not mean absolute safety for the project. Auditing is a necessary means but not a one-time solution. One must always be aware of the risks of depositing funds into smart contracts.
There are significant potential risks associated with anonymous project teams. Even if it is proven that they are a fraudulent group, it is difficult to hold them accountable. Mature on-chain analysis tools can help avoid scams, and if the founder's identity is verifiable, the project is more reliable. However, projects led by anonymous teams are not necessarily scams, and many legitimate projects are the work of anonymous teams. However, when evaluating project risks, potential risks associated with anonymous teams must be considered. It can be difficult to hold anonymous founders accountable for illegal behavior.
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Token distribution is a key factor to consider when researching DeFi projects. One illegal way unscrupulous developers profit is by manipulating the price of tokens. They achieve this by holding a large number of tokens. They then sell them on the market when the price rises. While some may think that the founder team holding a large share of tokens poses no risk, it may lead to a series of issues.
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It is also necessary to consider token issuance methods. Is the project conducting an exclusive presale, allowing insiders to accumulate a large amount of tokens before promoting them on social media? Is there an initial coin offering (ICO) activity, or an initial exchange offering (IEO) activity backed by a cryptocurrency exchange platform? Are there airdrops that generate significant selling pressure, among other factors?
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Liquidity mining is a new method of launching DeFi tokens. It refers to users locking funds in smart contracts and receiving a portion of newly minted tokens as a reward. However, its risks should not be ignored. Some projects directly inject locked funds into liquidity pools, while others use more complex mining methods or conduct large-scale pre-mining.
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In addition, new Shitcoins are usually listed first on Automated Market Maker (AMM) systems, such as Uniswap or Sushiswap. Even if the project team injects strong liquidity into the market trading pairs in the AMM system during the initial stage, they can withdraw the tokens and sell them in the market at any later time. This will cause the token price to collapse and fall almost to zero. Retail investors will have almost no opportunity to sell their held tokens.
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In addition, we recommend that you do not give smart contracts unlimited authorization. Giving unlimited authorization to spend authorized assets on your wallet is usually dangerous because malicious smart contracts can exploit this to spend the funds in your wallet.
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Whether participating in liquidity mining or exchanging/trading through decentralized protocols, it's possible to encounter various DeFi scams. We hope that the above guidelines can help DeFi participants accurately identify malicious projects and bad actors.