DeFi Exit Scams: What Investors Should Know About Safeguards and Checks

The crypto space is buzzing again, and unsuspecting investors are at risk of losing money. Having straddled the ends of decentralized finance tokens that have provided staggering returns, scammers are flooding AMMs with fake tokens to drive “scams”.

In a ‘pull the rug’ or exit scam, the scammer places liquidity in an AMM (Automated Market Maker) like Uniswap, only to take it out from unsuspecting buyers, leaving them with serious losses. These “pull the rug” scams occur as fast as 30 minutes after the launch of the token, or over several weeks when liquidity gradually decreases.

In addition to the major exit scams that have hit the headlines, records of large decentralized exchanges contain unreported cases of scams and fake tokens. Bear in mind that not all rug-pulls are of very high value often, it is small or micro-cap raises that steal funds from investors, with the effects of which go largely unnoticed by the wider community.

In early November, Binance said it had secured approximately 99.9% of the $345,000 cryptocurrency value stolen by the alleged automatic market maker Wine Swap in October. The operator fled with users’ cryptocurrency “within an hour” after fundraising at launch. The exit scam was carried out by moving 19 different cryptocurrencies stored in the Wine Swap address.

Commenting on the rise in listings of fraudulent tokens on AMMs like Uniswap, Thor Chan, CEO of AAX exchange noted that the problem is not unique to the DeFi space, stating that fraudulent listings can occur in all types of markets. He said the problem was not Uniswap’s open listing policy, but the lack of knowledge translating into the awareness of some investors.

What Investors Should Know About Safeguards and Checks

While it is difficult to identify exit scams, investors may want to keep the following points in mind before making an investment decision: Non-existent teams, extravagant profit forecasts, and fuzzy business models can act as checks in identifying exit scams. Offers with large shares may not always be dubious – the investor should exercise caution and conduct background checks on the claims presented.

As stated in Investopedia, ”The anonymous world of cryptocurrencies adds more risk due to its non-regulated nature”,  therefore DeFi may require some safeguards in place.

Automatic market makers such as Uniswap can interoperate with protocols that have features that allow investors to check if new coins have gone through any verification process. In explaining how such safeguards might work, DEX exchanges may need to interact with tools that legitimate projects can use to separate themselves from scams, such as their liquidity lock.

The app community’s response was to create ”Proof of Locked Liquidity” tokens in which Uniswap’s liquidity is provably, permanently, and irrevocably locked in Uniswap, usually through the burning of liquidity pool tokens.

The LID Protocol is an example of this as it provides licensed proof of locked liquidity for pre-sales and DEX launch solutions. To address these liquidity issues at Uniswap, the Liquidity Dividends Protocol introduces its LIFTOFF project as a revolutionary means of fighting smaller-scale scams. LIFTOFF has automatic and permanent liquidity lock and token audit requirements if not using standardized ERC20 contracts.

While other projects such as Unicrypt and Vesta Protocol aim to address these liquidity problems on Uniswap and similar DEXs, LID Protocol remains at the forefront of providing safeguards for investors and projects as tokens are burned automatically, which places and permanently locks liquidity in Uniswap.