- DeFi is the fastest area of growth in crypto, with over $200 billion locked in total assets.
- Fraud is rampant in DeFi, to the point where some industry insiders feel it may implode on itself.
- Insider asked three DeFi industry vets for tips to help DeFi beginners avoid the most common scams.
Crypto is the Wild West of investing, and DeFi, or decentralized finance, is at the forefront of the fast-growing and lightly regulated $2 trillion industry. Within the past year, DeFi’s total-value locked has exploded from $630 million to over $200 billion as it gains widespread acceptance from individual investors and institutions alike.
But not all crypto fortunes are made legally. According to Chainanalysis, 79% of all cryptocurrency scams last year came from DeFi alone, and the fraud targets everyone, from average Joes to tech billionaires. Rug pulls, or scams that entice investors to put their money into a crypto project only for the founders of the project to run off with all of the money, are a particularly common form of fraud in the world of DeFi. Be it the thousands of investors who lost their money in the SquidGame DeFi token rug pull, or Mark Cuban, who lost $200,000 on a DeFi token that got rug pulled, anyone can call for a DeFi scam.
With so much opportunity to be found in the world of DeFi, it can be awfully enticing for new investors to want to jump in headfirst. But with fraud so prevalent, anyone who wants to join the fray needs to know what sort of scams they should watch out for.
What is DeFi?
DeFi is growing so dynamically that it’s hard to come up with a single definition for the nascent industry. But in general, DeFi refers to the different protocols that utilize blockchain technology in order to conduct financial operations.
Some of the common investment ideas that fall under the umbrella of DeFi include staking, lending, margin trading, DeFi native tokens, and stablecoins. Simply put, DeFi is shaking up the traditional finance world, and has quickly become too big to ignore.
According to Hamzah Khan, the head of DeFi at Polygon, “DeFi is a revolution that is allowing average investors to utilize investment protocols that only major institutions had access to previously. Investors who want lucrative returns cannot ignore it because the smartest minds are all entering this field. It is the future.”
However, this “future” is rife with fraud in the present. Recent examples of DeFi scams include the Beanstalk attack last week where hackers made off with over $180 million, and an iCloud phishing scam that cost one MetaMask user $650,000.
Many scams are designed to target new investors who aren’t particularly tech savvy, which is why it behooves those investors to know what they should be on the lookout for and how to avoid some of the most common forms of DeFi fraud.
Stick to DeFi tokens on centralized exchanges
There are many different ways to interact with DeFi, and one of the most common is to use decentralized exchanges, or DEXs, like Uniswap, PancakeSwap, or SushiSwap, to trade with other investors for niche DeFi projects. But for someone just entering the world of DeFi, these exchanges pose unnecessary dangers.
Decentralized exchanges are peer-to-peer exchanges where two individual traders exchange cryptocurrencies. They typically lack the clean interfaces that major exchanges like Coinbase, Binance, and Gemini have, and focus mainly on creating a marketplace for a vast variety of cryptocurrencies.
However, by nature of being a decentralized exchange, there aren’t any regulators vetting the projects that are listed on the platforms. As Akash Takyar, CEO of LeewayHertz Technologies, recently wrote “Any ERC-20 token can be launched on Uniswap if there is a liquidity pool available.”
In simpler terms, pretty much anyone can list a token on the major decentralized exchanges — which means pretty much anyone does.
Discerning legitimate DeFi projects from illegitimate ones is difficult enough for experts, so for average investors who don’t have the time to spend hours pouring through projects and sussing out scams it’s even more problematic.
Josh Olin, the founder of the GTFO (Get The Fraud Out) cryptocurrency, has dedicated his career to weeding out fraud in DeFi. His advice for beginners is to only use centralized exchanges. Olin told Insider in a recent interview that “Coinbase, Gemini, or Kraken have to vet the projects that are listed on their platform. You know that there’s a layer of security that a publicly traded company like Coinbase takes before it lists a token on its platform.”
Be wary of “gem-talkers”
“Gem-talkers” is a colloquialism used to describe influencers who promote crypto projects online to their audiences via social media. They often promise huge returns with headlines touting big profits in a short amount of time, get thousands of likes and retweets, and seem to be credible at first glance.
But gem-talkers don’t have any form of financial verification, hence the emergence of the meme phrase “not financial advice” that has become prevalent across social media, and often have built their online followings using social engineering and click-baity titles.
Allen Lee, former MIT researcher and the founder of Beta Finance, told Insider that “he ignores social media DeFi advice,” and recommends visiting websites like RugDoc.io, which showcase some of the most common techniques that malicious actors use to scam people.
Be realistic and do your own research
Part of crypto’s major allure for investors is the promise of enormous gains — but sometimes newer investors are so eager to make money that they forget to do their homework. Tushar Aggarwal, founder of crypto staking company Persistence and general partner at Outlier Ventures, said he “recommends reading at least one audit report” of a project before he considers investing.
Moreover, it is a good idea to focus on projects with public founders. Projects like Algorand, founded by MIT award-winning computer scientist Silvio Micali; USDC, founded by former venture capitalist and early internet pioneer Jeremy Allaire; and Chainlink, which was founded by Sergey Nazarov, an almost decade-long crypto veteran, all have public-facing leadership.
This is important in building trust for investors because it means that the founder of a project cannot simply take people’s money and then vanish. Their reputations are staked alongside the project, thus they can’t just rug pull and disappear the way an anonymous founder could.
Obviously, not every DeFi project will have such esteemed public founders, but checking a founder’s background, and looking into the background of the project itself, is an important step before committing capital.