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Crypto Ponzi Schemes are Flooding DeFi

In recent years, Ponzi schemes have been using decentralized finance (DeFi) infrastructure to defraud their victims. The article examines DeFi's ecosystem and how fraudsters take advantage of it to steal from crypto newbies.

In recent years, Ponzi schemes have been using decentralized finance (DeFi) infrastructure to defraud their victims. The article examines DeFi's ecosystem and how fraudsters take advantage of it to steal from crypto newbies.

DeFi refers to financial infrastructure and services provided over public blockchains using smart contracts. These blockchains allow developers to build decentralized applications (dApps) on Ethereum, Binance Chain, Cardano, and Solana. While there are numerous uses for dApps, the majority are financial.

The development of DeFi has advanced to the point where token creation templates exist, allowing anyone to create a token within minutes without any programming experience or knowledge. A Pandora's box opens in which token creators can create excellent dApps, while malicious people can create malicious ones, including the infamous Ponzi scheme.

The Ponzi scheme is illegal in practice. Nevertheless, some blockchains are decentralized, and no single jurisdiction is responsible for enforcing compliance with local laws. The operational oversight of some centralized blockchains is lacking. Ponzi schemes can then be set up on these chains by fraudsters. Blockchains that facilitate the development and deployment of dApps do not require a know-your-customer (KYC) procedure. People can therefore build them incognito.

In the DeFi space, how do Ponzi schemes work? Ponzi schemes pay existing investors with money collected from new investors and are named after Italian con artist Charles Ponzi. Investors' funds are not necessarily invested, but they are promised high returns in a short period, which in many cases exceed traditional yields.

Ponzi schemes collapse quickly if they do not attract new investors. Many investors withdrawing funds can also result in the Ponzi schemers closing their operations because they cannot honor the debt. In other cases, authorities may raid Ponzi scheme offices, and when the illegal nature of the scheme is discovered, the scheme collapses.

Eddy Alexandre, CEO of EminiFX, was the most recent victim of a Ponzi scheme in which he promised investors a weekly return of 5%. The FBI arrested him last week for allegedly defrauding his clients for more than $59 million. The monies would be invested in crypto and forex using a "Robo-Advisor Assisted Account" system. Before investing in such a product, be aware of scams and perform due diligence.

Ponzi schemes in the DeFi space may use a different method to defraud their victims. Sometimes, DeFi Ponzi scammers will sell tokens to unsuspecting buyers while promising high stake rewards. Ideally, it would help if you offered the next 100x ZRX +2.5% moonshot (a token sold at a low price with the promise that its value will increase 100 times) or promised high stake rewards for new token holders.

The most appealing features of DeFi ecosystems are stake rewards and yield farming. Because DeFi ecosystems rely on staked tokens for consensus, DeFi users will deposit and lock their tokens for a significant percentage yield. It is possible to accumulate ten x more tokens in a year if you stake on a DeFi platform that pays 1000 percent (yes, these platforms can pay that much).

Since most participants are staking, staking rewards result in token inflation, which drives the price down. The ecosystem must experience a substantial increase in new investors to offset the increasing supply for you to sell your staked tokens for a profit after a year. It is similar to other Ponzi schemes because it relies on new investors to maintain its value. However, not all people agree that they are similar.

Often, prices of DeFi protocols with high staking rewards collapse if they cannot draw new investors and burn excess supply. Fraudsters who sell tokens for Bitcoin, Ethereum, Binance Coin, or other supposedly valuable tokens make the most profit. The con artists sell their clients assets that they can inflate for assets they cannot, promise high returns, and flood the market with tokens they cannot inflate once the DeFi protocol is launched.

On the other hand, yield farming relies on the community to provide liquidity for participants to buy newly minted tokens through a decentralized exchange. Essentially, yield farmers buy a pair of assets for the same dollar amount. The first half goes to the newly minted token and the second half to a counter token/coin like Ethereum or USDT.

An automated market maker (AMM) platform (often referred to as a decentralized exchange) adds the new liquidity to a pool. This pool automatically distributes transaction fees to liquidity providers (yield farmers). Tokens such as Ethereum or USDT can be automatically converted for the newly minted token for new participants of this pool. Or fraudsters may charge high transaction fees to earn high yields from yield farms, and future growth is heavily dependent on a significant increase in new users. Tokens of the newly minted yield farm will be used to grant rewards. Fraudsters frequently exploit this automated liquidity as the DeFi Ponzi scheme expands by exchanging newly minted tokens for the counter coin/token, thus driving the price down to zero or close. Yield farmers and stakers become stuck holding billions of worthless tokens in DeFi Ponzi schemes.

Investors can gain value and utility from several DeFi protocols. Some organizations plan periodic token burns to prevent fraud through audit certifications to reduce inflation. When investing in DeFi as a new crypto trader, you must ensure the token you purchase doesn't rely on the growth of new users, which is reminiscent of Ponzi schemes. Additionally, if high returns promised by DeFi protocols don't result from value creation, but from new investors, the correlation with Ponzi schemes will increase.

The founding brothers of the Africrypt Ponzi scheme in South Africa allegedly stole $3.6 billion in what is considered the largest DeFi heist in history. Two brothers claimed they had an AI-driven trading system earning above-market returns before defrauding more than a quarter-million customers and claiming they had been hacked.