This one’s for you, Mom!*
If you’ve read any of my previous posts, you know that I’ve fallen victim to quite a few DeFi exploits (5.5+) in addition to numerous of those loosely-termed “soft rugs”, which are when a token’s price plummets into oblivion forever.
In honor of those exploits and soft rugs, my DeFi friends and I have come up with a couple of “red flags” newcomers should think about before investing in small marketcap DeFi projects.
1) A Money Printer without Revenue
This first one has two embedded questions: 1) Is the project printing a shit ton of their token from thin air? And 2) does this project have any/enough revenue to support this printing?
Question #1 should be directed particularly at yield farming platforms that simply emit their native token as a “reward” for providing liquidity, especially when users can provide liquidity without using the native token.
Personal Example
Fresh off an exploit, Polygon’s Iron Finance relaunched their new yield farming platform and distributed their new ICE token as a reward with staggering APRs.
When it launched, people bought the ICE token all the way up to $40+ so that they could get a piece of those juicy returns. I bought $50 worth.
No one was ready for Alameda (an investment firm with $1B+ in capital). Iron had a heavily-featured “triple” stablecoin pool that yielded 100%+ APY in the ICE token. And because they can, Alameda dropped $500M in that stablecoin pool. Imagine what they did with all those ICE token yields?
RIP to anyone buying ICE.
Question #2 refers to projects that indicate that holding their token “allows access to the platform’s revenue streams”. This type of claim may have honest intentions, but for most projects those “revenue streams” are still months or years from being realized — and to even achieve those “revenue streams” they need to attract value to their platform (through the crazy high token emissions).
So, before you buy the platform’s token, check how much “revenue” the project has accumulated and how that same revenue is being distributed to holders (see Red Flag #6 for more about this).
2) Only Token Use Case = “Future Governance”
This red flag is commonly seen in projects that still haven’t figured out what they want to do (or can do) with their token. This is mainly seen in protocols that are providing an actual service of some kind (lending/borrowing for example).
Personal Example
As I was digging into some yield farms on Raydium, I came across a freshly-launched lending-borrowing protocol called Larix. In their protocol, users could lend and borrow various assets and receive the Larix token as a reward for either action.
But what could users then do with the Larix token? Well, according to the docs and their discord moderators, users could stake it in the LARIX-USDC LP for more LARIX rewards, hold on to it for “future governance”, or simply sell the LARIX back for USDC.
Seems like an easy choice for savvy degens. Thankfully I realized this flaw quickly enough before LARIX completely tanked.
The point here is that “future governance” is both vague and unprofitable. What does this governance entail? Do I vote on things? Do I even care about the project enough to pay attention to voting? And most importantly to us DeFi apes, how can I possibly make more money by voting?
Platforms like Larix appear legitimate and they remain important pieces of a fuller DeFi puzzle, but as far as “buying the Larix” token goes, steer clear until the use cases are fully developed.
3) Low Entry Barrier on Play-to-Earn Tokenomics
Play-to-Earn tokenomics are almost always broken. This is because there are larger groups of people out there in certain parts of the world that are willing and capable of dedicating entire days to “farming” and playing the system. They are trying to earn an actual living, whereas the casual investor might be looking for something simple to earn a few dollars here and there with a “game.”
There are a few platforms that have worked out fairly well, like Axie and Defi Kingdoms, but for the most part I’d strongly recommend staying clear of these systems at least until the game token(s) have had a chance to settle into their actual price and it’s clear the game is playable.
Personal Example
Somehow, somewhere, someone told me about a BSC play-to-earn game called Plants vs Zombies…or wait, no, Plants vs Undead was the name.
I wonder why I thought it was “zombies”? Huh.
Anyhow, I checked out the “game” and watched a few YouTube videos, and as it appeared to be in its nascent phases I thought maybe there was an opportunity to do some light gamified farming. I bought a little bit of the PVU token ($100 worth) and used that to get my plant farm going.
My $100 was rekt within a week. Why? Because I didn’t understand that while I was casually clicking on my lil farm once a day, there were thousands of users around the globe that were running 20–30 farms on 10+ devices.
So I’m thinking “ooh, I’ll water my plants, collect the rewards, and I’ll have enough in a month of clicking to get my $100 back”. And at the same time, the panicking game devs are trying to “fix the tokenomics” and slow down mass farming with higher and higher conversion rates.
10 minutes of pre-investment investigation into their Discord server would have saved me the trouble (and the $100).
If it’s cheap to get started in these games, then rest assured, there are “play-to-earn” 24-hour farmers out there that are going to run its token into the ground. The only way around this is to find opportunities like StepN, for example, that both cost a lot to enter (8 SOL+ for an NFT game token) and also limit your “energy” for the day (10 minutes max for entry level).
Even then, though, there’s no harm in waiting to see how the prices play out.
4) Hyper-Inflationary “Currency Reserves”
Just don’t.
Don’t do these.
Unless…
No, no, no…mustn’t do these.
But maybe this time…
Personal Example
Invictus, SnowBank, TIME, Euphoria, Klima…only the 1st one on this list didn’t leave me in total rektedness (because I came in late enough).
These Olympus DAO forks (OHM forks) draw in initial investors with crazy high APYs (sometimes in the billions). They are supposedly “backed” at $1, which means if the price of the token ever fell below $1, the DAO would use the vast treasury reserves to buyback/burn the token. Anything above $1 is a premium that investors are paying to get early access to this grand money printer. The theory is that no matter what premium you are paying (within reason of course), eventually you will “make money” due to inflation rates and the treasury support.
The problem is, I never got to see if this was true. No OHM fork has been allowed to sit at $1 to see if the treasury will support it because they all “rage quit” (ie, “redeem the treasury at the backed price”) before that happens.
Invictus DAO’s price action was heading towards $1 with a dev team that had mainly quit and bearish whales wanting out, but there was a quick vote and redemption came instead.
So the moral of the story is, just don’t do these anymore…unless…unless…
You can trust the devs (in case of redemption) and there’s more in the treasury than the current marketcap of the token. Though that scenario is still not risk-free by any means, at least you can avoid a decent amount of rektage by buying the token at $10 vs $1000.
5) Mismatching Docs
This red flag is short and simple. Check the tokenomics in the platform’s gitbook*. If there are broken links, empty addresses or just general “unintelligibility”, at the very least you should enter the project with some amount of skepticism and caution.
*If there’s no gitbook then that’s another red flag.
Personal Example
SMRTr Coin was supposed to be new and improved version of SMRT Coin (a protocol included in the next red flag). Using a “selling” tax system, they were supposed to be implementing “amazing buyback and burns” of their hyper-inflationary SMRTr token.
I was already in deep at that time and I was 100% in my “trust these guys know what they’re doing” stage of DeFi investing. So when I went to the SMRTr Coin docs, looked at their “SMRT buyback and burn” wallet address, and saw that it wasn’t doing anything, I didn’t back out immediately.
Eventually I did exit (at a slight loss), but it would have been with gains if I had realized that these guys didn’t actually know what they were doing and the docs were evidence of it.
True, maybe the protocol’s docs are just out of date. Maybe they have a typo in the wallet address. Or a team member or the code has changed around a bit so they’ve lost track of things. Before you invest though it never hurts to pop into their discord to find out what’s going on with the docs. I believe those types of questions were the original purpose of these DeFi discord servers…right?
6) “CRAZY NEW INNOVATIVE REVOLUTIONARY AND AAAWEEESOME AND CRAZY!”
Any of these kinds of tokenomics — if they use a lot of these words, plus a bunch of CAPS and EXCLAMATION POINTS!!, hold off.
Your money is better off in the fireplace where at least these guys in the GIF can’t use it to make more hype machines.
Personal Example
I have a few that fit this one. As I mentioned before SMRT Coin had this “crazy” mechanic that would double the APR every time the TVL doubled. It was supposed to be a “ponzi scheme on steroids” where people could pump out thousands per day in yields as long as people kept buying in. For a few it worked, for most it didn’t.
Iron Finance, also mentioned before, was another good example. They had “solo vaults” where users could stake their LPs away in their own special contracts with 1B% APY. Those were rekt within days by a bank run and code glitch.
My favorite example was my foray into SnowDog. It was supposed to be a “degen experiment of the highest order” in which at the end of a countdown the treasury would break apart the LP and perform “one of the biggest buyback and burns in history.” For days and weeks before the event, discord degens everywhere discussed how “immensely valuable” their SnowDog token was going to be…there were even websites built with special calculators to try to estimate the stupid crazy gains.
Here’s a calculation: What’s 2 SNOWDOG bought at $1200 apiece worth when it’s multiplied by $30 in the end? Lemme see here…I need a website for this.
Really rekt. Everyone rekt. Except of course for a few “fortunate” users who seemed to have suspicious knowledge of how the buyback was going to happen.
Anyhow — these crazy “flash-in-the-pan” get-rich-quick tokenomic schemes are all over DeFi. They only benefit a select few and it most likely won’t be you.
And that’s a rhyme so it must be right.
So, in the end,
I have probably haven’t done all of these “red flags” justice or been 100% technical or correct, but it’s just how I see them.
If you’re interested in discussing these red flags or other tokenomic issues, please come join us in NomDAO!
We’ve got some people in there that even know the difference between “unlimited supply” and “infinite mint” — I still don’t get it but only because I don’t want to, teehee.
*Mom is my blog’s Number #1 Fan.
