Ponzi Schemes in DeFi: Why You Should Be Wary of High Interests
The evolution of decentralised finance (DeFi) has changed the existing traditional banking approach to offering financial services.
In particular, the past two years have seen decentralised applications (dApps) intensifying their efforts to deliver traditional finance (TradFi) services — but in a permissionless, automated, and transparent way.
Hence, despite their shortcomings, dApps — using public, decentralised blockchain networks — have finally brought financial products to everyone with an internet connection. From lending to loans and staking, these automated applications have proven their potential.
This increase in access to financial services is unprecedented — the total value locked of digital assets in DeFi’s evolving open-sourced financial system spiked from a meagre $1 billion in mid-2020 to over $180 billion 18 months later.
Also unprecedented is, perhaps, the scale of losses accompanying dApps’ adoption while trust from the unbanked still keeps increasing.
A plethora of Ponzi schemes sprung up — interests come from onboarding new investors
One of the ways the losses come to light is through Ponzi schemes, particularly when they collapse. Amongst other things, the ability to create dApps anonymously has given room to Ponzis in the DeFi space.
This form of investment fraud is simple. The massive returns that are promised to existing investors are paid simply by using funds from new investors. Schemers mainly seek to attract new money by luring investors with the promise of high returns with little to no risk.
Ponzis sometimes lead to other kinds of fraud, like yield farming and rug pulls.
The projects use their offer of returns, particularly inflated interest in investments, to make many retail investors fall for their schemes despite obvious red flags.
DeFi tokens with high inflation rates — interests come from “liquidity mining programs”
This group of DeFi tokens employs a liquidity mining program as a strategy to attract users. Participants lend crypto assets to DeFi protocols in exchange for incentives. The users are rewarded with new tokens that enter the circulating supply on a daily basis and increase the tokens’ sell pressure.
An analysis by Multi.io Research outlines three cases of such tokens mentioned below that were unable to recover, unlike others, after a correction in the market. It concludes that because of their operational model, it is hard to know when the value of their tokens is at the bottom. It is also unclear what would become of the model in uncertain market conditions when there are not enough buyers to cover demands.
Such high-inflation tokens include Compound Protocol which makes users deposit their idle assets for other users to borrow. Its liquidity mining program rewards 2,312 COMP tokens daily as earned interest which translates, when calculated based on the prevailing market cap as of the time of the writing, to a 25% inflation rate.
It is even more so for the largest decentralised Automated Market Maker (AMM) exchange in DeFi, Uniswap (UNI). The exchange allows anyone to create a market, provide liquidity, and earn 100% of the trading fees (at 0.3%). Its liquidity mining program rewards 83,333 UNI daily at a 66% inflation rate.
There is also Curve (CRV) as a decentralised AMM exchange that has admin-only created liquidity pools. Its inflation rate is put at 920%.
D/Bond — interests come from verified bond issuers
On D/Bond, interest payments on investments come from verified bond issuers — companies, organisations, and people. Our verified issuers use investors’ funds to expand operations or re-invest them to cut their costs — thereby generating profit. It is from this profit that they pay interest to their bond buyers, the investors.
Since we make them back up their decentralised bonds with a portion of their pledged debts in advance, even if they make no profits, your principal is still secure to a certain extent. For fixed-rate, guaranteed D/Bonds, however, your full principal and interest payment are 100% guaranteed.
We are bringing a coveted asset class to the blockchain for everyone — even the underbanked across the globe, with a sound ecosystem built around it. To make this as efficient as possible, we have pioneered the ERC-3475 token standard (read about its acceptance here) to make decentralised bonds available.
Our comprehensive ecosystem makes the difference
Our DeFi bond creation, trade, and market-making platform would introduce many individuals and institutions to the massive untapped opportunities of financial securities. We engage our users at every stage of the bond process. From the decentralised-like funds management approach to meet specific investment goals for the benefit of investors to using an on-chain proposal voting procedure as part of a governance system, the interest of the D/Bond user community is paramount.
With the innovative ERC-3475 token standard, and the broad bond-issuing implementation it enables, our governance procedure helps improve investment decisions and our community members participate all through the process.