Decentralized finance has a lot of promise for investors but is also rife with danger. Here’s what you should know and how to avoid getting scammed.
Decentralized finance—called “DeFi”—refers to the shift from traditional, centralized financial systems to peer-to-peer finance enabled by decentralized technologies built on the Ethereum blockchain. From lending and borrowing platforms to stablecoins and tokenized BTC, the DeFi ecosystem has launched an expansive network of integrated protocols and financial instruments.
While the DeFi ecosystem has unlocked a world of new possibilities for crypto users, it has also given rise to several scams and bad actors. So, let’s explore some of the most common DeFi scams and how to avoid them.
Ponzi schemes have been around for centuries, but they’ve taken on a new life in the DeFi space. In a Ponzi scheme, early investors are paid returns out of the capital raised from later investors, giving the impression that the project is profitable when it’s actually insolvent. You should read our piece on the BitConnect Ponzi scheme if you want to know more about how it works.
Exit scams occur when a project raises money from investors and then disappears, taking the money with them. This scam is especially common in the Cryptocurrency ICO space but can also happen in the DeFi space.
Since DeFi protocols are built on the Ethereum blockchain, they’re also susceptible to Ethereum-based attacks. In November 2021, the DeFi lending platform bZx was hacked, resulting in the loss of over $55 million worth of cryptocurrency. The attack exploited a flaw in the bZx protocol that allowed the attacker to take out a loan, deposit collateral, and withdraw the collateral, effectively “borrowing” the funds without ever having to repay the loan.
How To Invest in DeFi Safely
To avoid being scammed, it’s essential to do your research before investing in any DeFi project. Be sure to read reviews and check out a project’s code before investing, and always be aware of the risks involved in any crypto investment.
So, how can you safely invest in DeFi? Here are a few tips:
- Diversify your portfolio across a variety of DeFi protocols to mitigate risk.
- Pay attention to the network effects of the protocols you’re invested in. Stronger network effects tend to lead to more resilient protocols.
- Keep an eye on gas fees and use protocols optimized for low fees.
- Stay up to date on the latest developments in the DeFi space. New protocols and features are being released all the time, and keeping abreast of the latest news will help you identify new opportunities and avoid potential pitfalls.
Staying Safe in DeFi
You should also be aware of the signs of a scam, such as promises of guaranteed returns or unrealistic claims. If something sounds too good to be true, it probably is. By being aware of the risks and taking precautions, you can safely participate in the DeFi space and potentially earn high returns on your investment.
As with any investment, there are always risks involved. However, following the tips outlined in this article can help minimize those risks and increase your chances of success when investing in DeFi. Remember, you should only invest in projects you understand and have a solid track record.
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