The world of cryptocurrencies is still a very young and untamed area. On one hand, it offers opportunities for significant profits, but on the other, this digital Wild West is filled with pitfalls, unpleasant surprises, and the risk of losing all your assets in an instant.

However, a good number of crypto projects are highly legitimate and the technologies they utilize represent the near future. It is essential to separate the wheat from the chaff and focus on promising projects that can move society forward. At the same time, we need to keep our eyes peeled and avoid the rotten apples out there.

What are the most common fraud schemes in the digital asset space? How can you recognize a project that is legitimate and has a future? And what should you watch out for to avoid falling into scammers’ traps?

Types of cryptocurrency scams and how to avoid them

In the fast-paced and ever-evolving field built on blockchain technology, there are several ways scammers might try to steal your funds. Let’s take a closer look at the most common ones together.

Exit scam

An exit scam isn’t exclusive to the cryptocurrency world, it can occur in virtually any industry. It occurs when project creators collect money from investors or customers, promising goods, services, or returns, and then suddenly disappear with the funds without fulfilling their promises.

How does an exit scam work?

• Offer and Promotion: Perpetrators of an exit scam often present an attractive product, investment opportunity or service, marketed as highly lucrative or unique.

• Fundraising: Once they successfully attract investors or customers, the project creators begin collecting funds, often leveraging various marketing techniques and promises. A common method is "shilling," where interest in the cryptocurrency is actively boosted through social media or influencers.

• Exit: After reaching their desired amount of money, the scammers suddenly disappear. They may shut down websites, disconnect phone lines, delete social media profiles and withdraw from public life. Investors and customers are left without explanations or compensation.

Exit Scams in the cryptocurrency environment

In the cryptocurrency world, exit scams can be particularly devastating due to the digital nature of the assets, which makes transferring and concealing funds much easier. These scams often involve fraudulent ICOs (Initial Coin Offerings), where creators vanish after raising funds, or fake exchanges that shut down operations and disappear with users' assets.

How to determine that a project does not show signs of Exit Scam?

Transparency and communication from the team behind the project is absolutely essential to eliminate the risk of exit scams.

A credible project should therefore meet the following characteristics:

• A transparent team

• Clear communication and updates on the status of the project

• Roadmap or vision for the near future

• Clear documentation including a whitepaper

Rug pull

Rug pull, or "pulling the rug out", is a term which translates as to suddenly and unexpectedly remove someone's support.

In the context of cryptocurrencies, a rug pull is a situation where a project team that controls a significant portion of tokens, coins or liquidity on a decentralized exchange unexpectedly withdraws liquidity or sells most or all of its cryptocurrencies. This dramatically drops the token price and the situation can be fatal for the entire project.

How to know that a project is not at risk of rag pull?

The biggest danger to the possibility of a rag pull is holding a large portion of tokens or coins in one or a small group of accounts. Therefore, you should look for projects where the distribution of tokens is wide and the individual cannot move the price as much. A positive sign is when a coin offers staking, where tokens are locked for a period of time and cannot be freely disposed of.

To prevent project founders from selling their tokens and taking their feet on their shoulders, for example, a vesting period can be used, where tokens are paid to project founders gradually. How tokens are handled within a project should be easily identifiable from the tokenomics of the token.

Ponzi scheme

A Ponzi scheme is a fraudulent investment structure that promises high returns to investors on the basis that new investors pay returns to those who invested earlier.

This structure is named after Charles Ponzi, who used this type of scam in the early 20th century. In the cryptocurrency environment, Ponzi schemes have unfortunately become common practice.

How does a Ponzi Scheme work in cryptocurrencies?

• Offer high returns: The scheme organizers offer high returns with little or no risk, often much higher than the normal market return

• Recruiting new investors: To pay returns to existing investors, promoters must continually recruit new investors

• No real profit: There are no real investments or legitimate ways to generate profit in a Ponzi scheme, the money simply passes from new investors to existing investors

• Collapse of the scheme: Eventually the scheme collapses because there are no more new investors to cover the returns to the existing ones, the promoters often disappear with what's left of the money

How to spot a Ponzi scheme?

Ponzi schemes in the cryptocurrency space are one of the biggest threats to inexperienced investors. It is a sensitive issue that requires attention and caution. It's always a good idea to be skeptical of overly good offers and continually educate yourself on the area you're investing in.

To avoid falling into a Ponzi trap, it’s crucial to thoroughly study the project or do what is known as DYOR (Do Your Own Research).

A key factor that can rule out a potential Ponzi scheme is the way in which the project generates income for its participants. If the project offers products that generate real profits and can sustain itself financially, it is a good sign that the venture may be legitimate.

Pump and dump

Pump and dump is another type of investment scam that is common in both traditional and cryptocurrency markets. This tactic involves artificially inflating (pumping) the price of an asset, followed by a rapid sale (dump) for a profit by the organizers.

How does Pump and Dump work?

• Asset Selection: Organizers will often select unknown or thinly traded cryptocurrency, or even mint a new cryptocurrency where the price can be easily influenced.

• Inflating the price (Pump): Organizers start massively buying the selected cryptocurrency while promoting it through social media, influencers, forums, email campaigns, etc. They claim it has great potential or spread fake news to attract new investors.

• Price growth: As new investors enter the market and start buying, the price of the asset rises rapidly.

• Quick Selling (Dump): Once the price reaches the desired level, promoters sell their positions quickly, often for a large profit.

• Price collapse: Subsequently, the price of the asset plummets as new investors begin to panic and sell, leading to large losses for those who got caught in the scheme.

How to protect yourself from a Pump and Dump scenario?

Avoid overly good offers: If someone is offering quick profits with little or no risk, you should be wary.

Be skeptical of unknown sources: If someone you don't know offers you an investment tip or advice, check their motivation and verify the information.

Watch out for unusual trading volume: A sudden jump in trading volume can be a signal that something is wrong.

Do Your Own Research (DYOR): Before investing in any cryptocurrency or other asset, take the time to research and verify the information you have.

Invest wisely: Never invest more than you can afford to lose, and be cautious when investing in unknown or risky projects.

Warning signs that the project is a cryptocurrency scam

To determine if project is a scam, it helps to focus on its suspicious aspects. Projects that are most likely to fall into the above fraud schemes are often characterized by the following warning signs.

1. Too high returns

If someone is offering you extremely high returns that are incomparable to market rates, this should be your first warning sign.

2. The absence or poor quality of a whitepaper

If the project creators cannot clearly explain how the project is able to generate such high returns, you should be cautious. The most complete information about the project should be included in the whitepaper, which should contain all the essentials.

3. Pressure to invest quickly (FOMO)

Fraudulent schemes often exert strong pressure to invest quickly. These projects try to induce the so-called FOMO (fear of missing out), i.e. the fear that if they do not buy in, they will miss the opportunity to get rich.

4. Lack of transparency

If the project promoters do not want to provide any official documentation or delay answering questions about the operation of the investment, this may be a sign of fraud. Cryptocurrencies, however, have the advantage of maximum transparency over traditional finance thanks to the blockchain. Therefore, it is advisable to look for projects that use this feature for the benefit of their clients and, for example, use the services of an external auditor for transactional movements within their products.

5. Anonymous team or use of made-up identities

A serious crypto project should always be backed by an individual or team of people who are not afraid to go out on a limb and stand behind their project. If the creator hides or fakes their identity, quite often they don't have the purest of intentions.

6. Suspicious or copied smart contract

To ensure the project is technically sound, scrutinize the foundation it’s built on. Many projects purely copy existing code from other projects and just rename them, while others are of poor quality and prone to exploitation. It is therefore advisable to seek advice from external experts. For instance, companies like CertiK, a renowned auditor of smart contracts, evaluate various projects and assess their risk levels. Project evaluations are freely available on their website.

Summary

Cryptocurrencies offer numerous opportunities for investment and trading, but they also come with risks. Various types of fraud, from fake investment opportunities to phishing attacks, can occur and threaten the financial security of individuals.

The key to protecting against these risks is to be aware of potential threats and protect yourself through measures such as using verified platforms, two-factor authentication, and continuous education on cryptocurrency security practices.

Through vigilance and proper understanding, we can take advantage of the opportunities that cryptocurrencies offer without exposing ourselves to unnecessary risks.