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Avoiding Scams in Crypto
- Jules Servius
- July 8, 2022
- 3:01 pm
- No Comments
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Identifying and Avoiding Scams in Cryptocurrency
DYOR, or “Do your own research” is a common acronym in the crypto space. These four iconic letters are seen everywhere, strewn across various crypto related blogs and chats as a disclaimer. You want to protect yourself from potential scams, but do you really know how to effectively do your own research? Let’s discuss some of the most prevalent scams within the crypto sphere.
Rug Pull
The term “Rug Pull” derives from the old saying, “To pull the rug out from under someone”. This term is used to describe the act of suddenly or unexpectedly removing support, help, or assistance from someone with little to any notice. As it pertains to crypto, a rug pull is conducted when a development team abruptly abandons a project and steals or sells all of its liquidity. Rug pulls are most analogous with newly launched DeFi token projects. Brand new projects typically are not listed on Centralized Exchanges (CEX). This means that a Decentralized exchange provides for the only available liquidity. There is currently relatively little regulation on cryptocurrency, which makes a rug pull a valid concern. Rug pulls most frequently occur during the post launch phase when hype is at its peak. You may see various call channels, Youtube videos, and Twitter shillers promoting the project in high volume. This may cause a rapid increase in the price of the token. If the liquidity is not locked, this is an opportunity for the development team to remove the liquidity and thus cause the chart to crash. To help prevent yourself from becoming a victim of a rug pull, it is important to research the totality of the circumstances surrounding a project. Look at items such as the token official social media, website, team, and most importantly in this case – ensure the liquidity is locked in a reputable liquidity locker such as Unicrypt. A transparent development team should readily provide proof of locked liquidity.
Honeypot
A honeypot is another type of scam we must consider when doing our research on cryptocurrency projects. Think about Winnie the Pooh for example. He sees a delicious pot of honey and sticks his hand inside to get a taste of that sweet delicious honey, only to find his hand stuck inside the jar. This is in essence the same thing that happens during a honeypot scam in crypto.
During a honeypot scam, developers launch a project which has a contract that is coded to only allow their own wallet addresses to sell. You may come across one of these projects and observe that the chart is heavily pumping with little to no red candles. One might think this is a good time to “FOMO” into the token without further verifying the credibility of the development team and their project. As time goes on more people buy into the token, thus causing the value to rise. You reach a point where you decide to take profits and sell some or all of your investment. It is at this point you will realize that you are unable to execute any sell orders. The developers of the project will eventually sell on their position at a time they deem profitable for themselves to do so and you are left with a handful of useless tokens in your wallet.
Detecting a honeypot scam early on may take a bit more due diligence than identifying a potential rug pull. It is advisable to first make a small purchase of a new token, followed by conducting a small sell order to ensure the contract gives you the ability to do so. Then if you choose, you can make a larger purchase with greater confidence and security. Another great resource you can utilize prior to making your decision is Token Sniffer. Enter the token symbol into Token Sniffer and see if there are any alerts on the contract indicating a potential Honeypot.
Abandonment
Abandonment, also known as an ‘exit scam’ is another type of scam you want to protect yourself from in cryptocurrency. Exit scams broadly refer to the act of developers disappearing with investor funds following an initial coin offering (ICO) or presale. How an exit scam typically works is a developer will begin to market and promote a token. After a large amount of funds have been raised, the developers will vanish from the project without any notice. Due to the anonymous nature of DeFi, protecting yourself from an abandonment or exit scam can be a difficult task, but there are a number of key indicators you can look for to help prevent yourself from falling victim. Starting with the team behind the project, you want to gauge their credibility and transparency. If they refuse to doxx or share their verifiable experience within the crypto space, this might be a red flag. It is also important for a development team to be active on all social channels on a daily basis. Take note of any remarkable absence from the projects lead developers. Another tactic from a team that may not be invested in their project for the long term is making unreasonable promises or price projections. Cryptocurrency is extremely volatile, and in today’s market it is difficult next to impossible to make an accurate price prediction for a brand new project. Next you should look at the social media accounts behind a project. Likes and followers can easily be purchased, but they are not genuine investors. These bot accounts can make a project’s following appear to be very strong. It is important to look carefully at the engagement of each post to determine follower authenticity. An account with 100k followers that has multiple posts with only a few likes and retweets is likely to be a heavily botted account. This does not necessarily mean the project will be abandoned, but it is still useful when weighing the totality of the circumstances when doing your research.
Slow Rug
A slow rug is a type of rug pull, except it happens gradually over time instead of abruptly at once. A slow rug is more difficult to detect than a standard rug pull because they can happen in front of your very eyes in plain sight and you might not even notice. Another key element to understand with the slow rug is that slow rugs most often occur in projects with locked liquidity. That’s right, just because a contract has locked the liquidity for any period of time does not make the project “rug proof”. Slow rugs occur when the lead developers of a project load multiple wallets belonging to themselves with a large amount of tokens in the prelaunch or early development phase with the intention of selling off these tokens as new investors come into the project. Every time the chart begins to show green candles, the developers will sell moderate amounts of their tokens, cashing in on investor liquidity and thus preventing the chart from growing. The mere act of a team taking profits does not classify a project as a slow rug. It is the intentional and repetitive act by a team continually dumping on the chart during an uptrend that dictates whether or not a slow rug is taking place. To help prevent you from investing in a slow rug, go to etherscan or bscscan and import the contract address. Here you will be able to observe all the actions a developer took prior to the launch during the coding phase. If you notice a large amount of allocated tokens making up a high percentage of the total supply distributed to wallets prior to launch that are now selling off, you should use extreme caution. You will need to conduct a fair bit of chart analysis when diagnosing a slow rug to determine the point at which strategic sell orders are executed and their frequency.
Solutions
Here we have touched on a majority of the scams plaguing cryptocurrency today and how you can better keep yourself safe. Safety begins with knowledge, and knowledge comes from education. A good investor realizes that he or she never stops learning. Cryptocurrency is still in its infancy and is rapidly changing with time. Conducting the proper research on a project may mean the difference between a solid investment and losing it all. Starting with your observation skills, you now have an idea of what to look out for and what questions to ask. What is the experience of the team? Is the team Doxxed? Is the liquidity locked? Do the social media and community behind the team appear to be authentic? These are all questions you want to ask before making the decision on whether or not to invest your hard earned money. Etherscan and Bscscan are invaluable tools available to everyone who decides to take the time to learn their inner workings, and it is well worth it to do so.
You now understand what it means to do your due diligence, but it is still important to remember that you always carry some level of risk as an investor. A good rule of thumb with any type of investment is to never invest more than you are willing to potentially lose. Armed with the proper tools and knowledge of how the crypto market works, you are better equipped to trade responsibly going forward.
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