Ask any non-crypto person why they are not interested in learning about the space, and one of the most common answers you’ll get is that crypto is filled with scams. While harsh, the sentiment does have some basis. One of the blockchain’s most defining features is decentralization, which grants participants greater freedom but also more responsibility. After a crypto transaction is finalized on-chain, it’s impossible to undo. If it was made in error or as a result of being scammed, the victim cannot appeal to any central governing authority to review and overturn.
Because the crypto space is filled with pseudonyms and wallet addresses that have no relation to real world identities, it often takes comprehensive and professional investigative efforts to unveil who exactly was behind any particular crypto scam. Therefore, any crypto enthusiast must be aware of how to best protect themselves from falling victim to potential hacks, scams, and fraud that runs rife within Web3.
What is a scam token?
A crypto scam token refers to a type of cryptocurrency or digital token that is created with fraudulent intent, designed to deceive investors and exploit the decentralized and often pseudonymous nature of the cryptocurrency market. These tokens are part of various schemes that aim to illicitly obtain funds from unsuspecting users. As the crypto space develops, the sophistication of scam projects evolve as well. Investors should exercise caution and conduct thorough research before making any significant investments, and be wary of unrealistic promises or guarantees. After all, scam tokens and projects come in all types and some initially pose as legitimate investment vehicles.
What are the common types of crypto scams?
Pump-and-Dump Schemes
In a pump-and-dump scheme, fraudsters artificially inflate the price of a token through false or exaggerated claims, often spread through social media or other online platforms. Once the price has surged due to increased demand, the scammers sell off their holdings, causing the price to collapse. This leaves investors who bought in during the hype with significant losses. Sometimes there are even constraints placed on the ability to sell your holdings.
One example of a well-known pump-and-dump is the Squid Game token ($SQUID) which grew fervently over just several days during the peak of the late 2021 bull market. However, buyers soon realized that they could not sell their $SQUID tokens unless they completed several convoluted steps including buying marbles, which were part of the project’s game. After the token had pumped by 75,000%, the founders initiated their scam by stealing all invested funds, leaving the price to crash in ten minutes to less than a penny.
Fake ICOs and Token Sales
Scammers may also create fake initial coin offerings (ICOs) or token sales, presenting a whitepaper and project that appear legitimate but are actually fraudulent. Investors contribute funds to these projects, expecting future returns, but the scammers vanish with the collected funds, leaving investors with worthless or non-existent tokens. These scams were highly prevalent during the 2017 bull run, which saw “ICO mania” as various types of projects, even those not making a blockchain product, sought to raise money through ICOs which were seen at the time as an efficient and easier way to crowdfund. From January 2016 to August 2019, ICOs raised approximately $13 billion worldwide. One example of fake ICO is Anubis DAO, which saw an initial token sale that raised $60 million in ETH. Unfortunately, 20 hours into the token sale, funds in the investment pool were transferred to a separate address and never recovered.
Rug Pulls
A rug pull occurs when the creators of a token, after attracting investments, suddenly and intentionally abandon the project. This results in a rapid decline in the token's value, leaving investors with virtually worthless assets. Rug pulls are often orchestrated by anonymous developers, making it difficult to trace and hold them accountable. They can also be called exit scams, as once a significant amount of funds has been raised, the project operators execute an exit scam by disappearing with the funds. The aforementioned $SQUID token is an example of a rug pull. The NFT space is also littered with rug pull scams. Evolved Apes was a hyped NFT project that generated buzz through its 10,000 piece collection and promises that holders would be able to battle others and win prizes. However, the developer pseudonymously known as “Evil Ape” suddenly vanished after completing the NFT sale and pocketing $2.7 million, halting on project development plans and leaving the price of Evolved Ape NFTs crashing in his wake.
Ponzi Schemes
Ponzi schemes involve crypto tokens that promise high returns to investors that can increase even higher if early investors can persuade others to join. Early investors are paid with the capital from new investors, creating a façade of profitability. Eventually, the scheme collapses as it becomes unsustainable, leading to losses for those who entered later.
One well-known case of crypto ponzi scheme is Bitconnect. This project boasted the ability to pay out 1% daily compounded interest on invested funds, as well as a multi-level marketing structure. The price rose from $0.17 at ICO all the way to $463 in less than two years, but subsequently collapsed. OneCoin was another significant ponzi scheme run by the self-titled “cryptoqueen” Ruja Ignatova. This scam is unique in that it actually never featured a token on the blockchain. Despite being called OneCoin and presenting itself as a cryptocurrency, it was never an on-chain token. Instead, participants were persuaded to purchase education materials and refer their friends and family to purchase as well.
Honeypot Scams
This type of crypto scam revolved around setting an attractive trap to lure in victims. A scammer can set up a wallet containing an alluring sum of tokens inside, let’s say $2,000 worth of an obscure ERC-20 token. The scammer sends out messages en masse to random strangers with the wallet’s private key and seed phrase, asking for help to transfer money and pretending to be a crypto newcomer. These strangers might see the message and realize that they have just been given the private keys to a wallet containing $2,000, so they may try to take the money for themselves. That’s where the catch comes in.
The “honeypot” wallet may contain a hefty sum of $2000 in ERC-20 tokens, but it doesn’t have any ETH to pay gas fees to transfer out the tokens. Therefore, the victims might look to transfer some ETH into the honeypot wallet in order to pay the gas fee for transferring out the $2000…but once ETH is transferred in, it is automatically sent out to another wallet owned by the scammer. This process is programmed via smart contract script, so it’s impossible for the victim to have enough time to actually initiate a transfer of the $2000. While each individual victim might not lose too much in ETH, since they’ll likely only try to transfer a small amount to pay for gas, the scammer can earn a great deal in passive income if enough people fall for the honeypot scam every day.
How to Avoid Scam Projects
To be successful cryptocurrency investors, one must be especially prudent to DYOR and avoid scams. Many fraudulent schemes prey on the investor’s greed at a prospective “big score,” since they know many individuals enter crypto in search of quick and significant profits. The way to identify a scam token project is by researching all of its aspects, especially the team, project, history, and whitepaper if available.
While not necessarily a foolproof indication of legitimacy, projects with publicized team members who have public social media profiles are considered safer than anonymous teams. Similarly, whitepapers that are written with technical and professional precision show that the project has been formed after detailed consideration. Whitepapers that contain language mistakes, plagiarism, overt use of jargon, and a general lack of thoughtfulness should be viewed with suspicion. Furthermore, the whitepaper should ideally present a detailed structure of the project’s tokenomics. If the founding team and associated entities hold too much of the total supply, it’s likely that the token price will crash should they decide to pull an exit sale.
Another fundamental part of your research should be on the technical aspects of the project’s token. Check what exchanges have listed the token, because prominent exchanges like Phemex feature an internal due diligence process before listing any token, so being listed on trusted exchanges is usually a good sign. Moreover, you can use a market aggregator or DEX to check the liquidity of a token. Illiquid tokens should be avoided since they are prone to volatile price movements and you may not be able to sell them conveniently at the market price.
It’s worthwhile to become familiar with certain tools that help you avoid scams. For example, Token Sniffer enables real-time monitoring of crypto tokens, and has assisted in identifying 250,000 potential rug pull scams since 2021. It provides users with information regarding token holders, liquidity, smart contracts, and swaps, and aggregates the data for an audit to determine potential security threats. Blockchain explorers should also be part of your arsenal for research and analysis. Tools like Etherscan and BSC Scan allow you to review on-chain activity for a specific project, as well as the founder’s activities in relation to the token. You’ll also be able to check community comments and ratings regarding the project, as shady tokens often develop poor reputations. Knowing which tools to use and what aspects of a project to check for will substantially enhance your scam detection skills and help you become a stronger investor.
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