The recent rise of the DeFi industry has attracted the attention of many investors while the lack of solid regulations has resulted in numerous scams. In this article, we are going to discuss DeFi tokens and give some advice on what investors can do to avoid money losses.
What is a DeFi token?
In a nutshell, a DeFi token is an asset or a utility token residing on blockchain and fueling its parent service or a platform. The spike in popularity of the decentralized industry has initiated numerous DeFi protocols developed for different goals and implemented in the environment of decentralized finance. The key practical use cases of DeFi tokens include:
- Lending and borrowing
- Creation, transfer, and exchange of value
- Securitization, assetization, and equitization
- Financial options and other types of betting based on smart contracts
The value of some famous protocol tokens has increased considerably and therefore attracted the attention of investors. If we look at the Polkadot project, for instance, we can see that its DeFi token price has increased by 900% over the course of the last 5 years. 900%, and that’s no joke!
However, with the growth of the DeFi token list, it becomes more challenging to select trustworthy projects for beginning investors. In the conditions of the decentralized industry boom, dozens of new cryptocurrency tokens appear every day, 90% of which may cease to exist soon after the launch. Liquidity is another problem of crypto coins as they are created with the only purpose of quick profits.
How to choose the right assets not to get into the trap? The understanding of basic notions helps to determine more reliable DeFi crypto coins for a secure investment.
What is DeFi?
So what is DeFi crypto? DeFi is a short term for decentralized finance, which is an umbrella term for decentralized financial applications or blockchain projects issuing their own cryptocurrency tokens. Their main feature is that they function without involving a third party in their work.
The DeFi platforms exclude the necessity of financial intermediaries thus forming an alternative financial infrastructure with DeFi instruments. In fact, DeFi is a reconstruction of the traditional financial system but in a decentralized environment. DeFi is based on smart contracts that will be discussed below.
What are smart contracts?
Smart contracts represent pieces of code that are used to alleviate the exchange of services, goods, funds, data, etc. The use of smart contracts is the main difference between decentralized facilities and centralized financial institutions where transactions are controlled by intermediaries.
The external data is processed without a centralized source so different mechanisms are employed for its verification. For example, reliable price feeds can be used to prove the accuracy of the DeFi tokens’ value. Smart contracts can pick up this data in an automated way and process the programmed activities accordingly.
To fuel the execution of smart contracts, tokens are used. As it’s been mentioned above, tokens are tricky as the whole industry provides fruitful ground for fraudsters of all kinds. Here’s what you can do about it.
How to verify DeFi tokens
While it’s rather challenging to enlist your token on centralized platforms, the DeFi platforms have made it simple. Thus, the most popular DeFi platform Uniswap enables the creation of open, free listings making the launch of new DeFi projects simple as 1-2-3.
On the other hand, there is no strict threshold keeping scammers away from the system, hence numerous fraud projects have emerged and flooded the industry. For instance, scammers can take a real, legitimate asset and launch a token with an identical ticker on a decentralized platform to mislead users and make them buy their worthless assets.
Those who don’t want to suffer losses invest in what is called ‘blue crypts’, which are recognized, well-established, and financially sound assets from the top DeFi coins. Numerous reputable resources come up with a list of DeFi coins that deserve to be trusted. At the time of writing, the DeFi leaderboard includes such decentralized platforms as Maker, Compound, Uniswap, Aave, and Chainlink that issue the best DeFi coins.
Here are some tips on how to select the best assets for investment and protect yourself against scams:
- There is a high probability of losing money when there is no solid technology behind the project, especially in the case of long-term investment. Check the project’s white paper to see if there is any innovation or if the document is simply copy-pasted from somewhere else.
- It is preferable to invest in projects that were highly assessed by reputable experts in the industry.
- Check how big is the portion of tokens allocated for the team. A too-large percentage (20%+) may lead to centralization while the total lack of vesting is not good either. Why would not the project reward its faithful workers?
- Explore the code or read the results of third-party smart contracts audits before investing. The failure in the code can lead to a hack and massive losses for users.
- Analyze the whitepaper and litepaper of the project to learn more about it and assess its potential. A project with thoroughly developed documentation is less prone to be a scam.
- There should be a team of non-shady people behind the project. The transparency of the team allows performing relevant checks on its members’ backgrounds to estimate their experience and skill set in their LinkedIn profiles, reputable publications, etc.
- It is essential to double-check the address of the project’s website and the contract address on a DEX. Analyze such details as the total liquidity, volume, and recent transactions.
- Use Tokenguard to read ICO reviews of the projects and verify the security of cryptocurrency tokens before adding them to your investment portfolio.
Following these guidelines wouldn’t fully protect you against losses. However, they can significantly reduce their chances. Remember: forewarned is forearmed.