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As the decentralized nature of crypto leaves room for anonymity, it also creates fertile ground for bad actors to operate. For every legitimate project, there are countless scams designed to defraud inexperienced and even seasoned investors. Identifying red flags in cryptocurrency projects can save you from substantial financial losses. In this guide, we will walk through key strategies to help you detect scams and avoid crypto fraud.
One of the most common pieces of advice in the crypto space is to "Do Your Own Research" (DYOR). However, many people are unsure where to start. Doing research in crypto goes beyond just reading headlines or social media posts. It requires a deep dive into the technology, team, and project structure. Understanding how to identify red flags, such as rug pulls and exploits, can save you from falling victim to scams. Here's a checklist that can help you evaluate crypto tokens, particularly those on Ethereum, Polygon, Arbitrum, Avalanche, and other EVM-compatible chains. You can check out our other academy articles for further research.
Before investing in any cryptocurrency, always start by researching the team behind the project. Legitimate projects usually have transparent teams with verified backgrounds in the industry. Look for the following red flags:
While some legitimate projects operate with pseudonymous developers, a project with no identifiable team members should raise concerns. Scammers often prefer to stay anonymous to avoid accountability.
Be wary of projects that claim to have high-profile endorsements without any credible evidence. Scammers sometimes fabricate partnerships with reputable companies or individuals to build false credibility.
A whitepaper is the foundational document of a cryptocurrency project, outlining its vision, technology, and goals. Scammers often create poorly written or plagiarized whitepapers to lure investors. Be sure to:
A well-crafted whitepaper should clearly explain the project’s goals, use cases, and how it intends to solve a problem in the market. If the document is vague, filled with technical jargon, or doesn’t seem to have a clear direction, it’s likely a red flag.
Scammers often copy sections of whitepapers from legitimate projects to create the illusion of legitimacy. Using a plagiarism checker to scan the document for copied content can help reveal whether the project is a scam.
Genuine projects typically have detailed roadmaps outlining future developments, partnerships, and milestones. Scrutinize the roadmap for signs of unrealistic or overly ambitious promises. If the project claims it will achieve significant milestones in an unusually short time, it may be an attempt to attract quick investments without delivering on promises.
Make sure the project is actively working toward its goals. If there’s no development progress or updates since the token launch, it could be a sign of an exit scam where the developers have no intention of following through.
An essential step in verifying a project’s legitimacy is checking whether the token’s smart contract code is verified on Etherscan, Ethereum’s blockchain explorer. If the code isn’t verified, it may signal malicious intent. Scammers often avoid verifying their code because it allows anyone to inspect the contract, exposing potential exploit mechanisms like unfair taxes or hidden withdrawal functions. While not all unverified contracts are scams, they are a significant red flag that should make you cautious.
The strength and transparency of a project’s community are key indicators of its legitimacy. Legitimate projects often have active communities where developers engage directly with investors. Red flags to watch for include:
If the project’s developers avoid answering tough questions or are absent from public forums, it’s a cause for concern. Scammers often avoid engaging with their communities to dodge scrutiny.
Beware of communities that seem excessively optimistic or are filled with bot-generated comments. Legitimate projects have balanced discussions, whereas scam projects rely on artificial hype to generate FOMO (Fear of Missing Out).
Tokenomics refers to the economics of a token, including its supply, distribution, and incentives for holders. Scam tokens often have suspicious tokenomic structures designed to enrich insiders while leaving retail investors with worthless tokens. Look out for:
A token with an excessively large supply may have limited value, especially if there is no clear mechanism to control inflation.
Scammers often allocate large percentages of the total token supply to the project’s team or early insiders, creating a situation where the founders can sell off their tokens and leave investors with a depreciating asset.
Legitimate projects will often undergo security audits by reputable third-party firms to ensure the integrity of their code. If a project lacks a public audit, or if its audit was conducted by an unknown or questionable firm, that’s a major red flag.
Look for audits conducted by well-known firms such as CertiK, Hacken, or Trail of Bits. These companies specialize in blockchain security and provide thorough audits to ensure the project's smart contracts are free from vulnerabilities.
The audit report should be available to the public. If the audit is hidden or difficult to obtain, it could indicate that the project is hiding security flaws.
One of the biggest red flags in the crypto world is a project that promises guaranteed returns. The volatile nature of cryptocurrency makes it impossible to guarantee profits. Scammers use this tactic to attract naive investors, but any project that claims guaranteed returns is likely a Ponzi scheme or a scam.
In the comments section of block explorers like Etherscan, you’ll often find user feedback on the token. If you see complaints or accusations of scams, take those seriously. An angry mob of comments calling a token a scam is a major warning sign. Make sure to leave your own feedback if you’ve been scammed to help others avoid the same trap.
DappRadar, a decentralized app tracking platform, allows users to submit scam tokens to a blacklist. Always check if the token in question appears on such a list. A token listed on DappRadar’s blacklist is almost certainly a scam, and it's best to stay far away from it.
If a token isn’t listed on popular platforms like CoinGecko or DappRadar’s Token Ranking, proceed with caution. Legitimate tokens will typically seek to be listed on these platforms for visibility and verification purposes. While not all unlisted tokens are scams, failing to appear on reputable token trackers increases the risk of foul play.
The number of exchanges listing a token is another critical indicator of its legitimacy. Tokens traded solely on decentralized exchanges (DEX) without any listings on centralized exchanges are at a higher risk of being scams. Centralized exchanges typically require rigorous Know Your Customer (KYC) checks and other vetting procedures, making it harder for scams to get listed. However, some legitimate projects prefer decentralized exchanges, so this should not be your sole criterion for judgment.
Low liquidity or trading volume is another red flag. Tokens with insufficient liquidity may be manipulated easily by the developers, allowing them to engage in pump-and-dump schemes. Always check the token’s liquidity on decentralized exchanges (DEXs) to ensure there is enough for legitimate trading activity.
A honeypot is a type of scam where you can buy a token but can’t sell it, effectively trapping your funds. To avoid this, always analyze the smart contract through tools like DEXscreener or TokenSniffer. These tools can help identify whether a token has hidden malicious code that prevents selling or includes exploitative fees that drain your funds.
Several tools can help you analyze the legitimacy of a token. These include:
A tool that evaluates smart contracts for red flags such as high taxes, hidden owners, and honeypots (scams where you can buy a token but can’t sell it).
This tool helps assess whether a project has been structured in a way that could indicate malicious intent.
While these tools are not perfect, they provide valuable insights and can be combined to give you a clearer picture of a token’s risks.
Whale wallets (wallets holding large amounts of cryptocurrency) and institutional investors can be good indicators of a project’s legitimacy. Tools like Nansen and Debank allow you to follow “smart money” and see which large investors are backing the project. However, even reputable investors can occasionally be fooled by scams, so this should not be your only point of reference.
Scammers will continue to exploit the decentralized, often anonymous nature of blockchain to create fraudulent projects aimed at separating you from your money. However, by following this checklist—conducting thorough research, examining the project’s code, verifying its team, and utilizing third-party analysis tools—you can significantly reduce your chances of falling victim to a crypto scam.
Always remember: in the world of cryptocurrency, skepticism and caution are your best defenses. Never invest more than you can afford to lose, and take the time to fully understand any project before committing your funds.