Imagine if someone is selling a property and a contract that automatically executes all the paperwork and communication between the parties, exchanges the right of possession of the property, and automatically transfers the payments without any delay, and reduces the burden on either party. Let’s talk about the smart contracts and what are the top 5 common signals which indicates that a smart contract is at risk.
Yes, that’s a smart contract for you!
A smart contract, in technical terms, is a set of computer programs stored on the blockchain that contain certain rules. These rules are agreed upon by two or more parties who want to interact or enter into a contract in the digital space.
The smart contract automatically executes itself to create the desired outcome if certain specified rules are met. In other words, it allows people to come to a mutual agreement in the digital space without the need for a third party to establish or verify the terms and conditions.
In simpler terms, smart contracts are just like regular contracts. The only difference being that they are entirely digital and have become the need of the hour. The upsurge in the digital ecosystem has given a push to the smart contracts economy.
Risks associated with smart contracts
Yes, smart contracts have numerous advantages, such as precision, safety, efficiency, cost savings, and transparency, but one cannot turn a blind eye towards the possibility of fraud or dangerous conditions that a contract may encounter.
Every coin has two sides and the other side of smart contracts is not that pretty.
The DeFi and smart contract space has already witnessed several crypto scams and has put the whole industry labeled as a scam. People have lost unimaginable amounts due to scams or hacks.
What could be even more intriguing than the ICO scams in the last decade?
Smart Contracts run on valuable properties that need to work in order to protect the assets locked in the contract from security risks and higher-interest scams.
That being said, there are some common things to look out for in a contract that indicates it to be risky.
First and foremost, to get the trust of your stakeholders, smart contracts need to be audited. This audit is one of the nerve points of your smart contract, thus it should be carried out from a reputed & trustworthy firm such as QuillAudits.
Other than the Audit, the following are the top 5 things you must check in a smart contract to identify if it is risky or safe.
- Token Lockup or Vesting Period
It is not impossible to distinguish between excellent and bad token offerings if one is aware of the crypto project’s “red flags.” The lack of a token lock-up period is one of the primary “red flags” that should be avoided when entering into a contract.
What can be the impact of a token lockup?
To put it another way, the token’s founder or sizable holders may vanish after selling all of the tokens at once on the market, especially shortly after the fundraising time has ended.
Token lockup, also known as the vesting period, validates a particular asset’s long-term worth by restricting cryptocurrency transactions for a set amount of time.
The conditions for releasing tokens are frequently injected into smart contracts. It summarises the regulations governing token lockup, as well as the transfer of tokens to certain addresses. This allows investors to participate in contracts with only lock-ups in a smarter manner.
Other red flags to notice are the team credibility, white paper documentation standards, and extraordinary return projections.
This scam is termed an “Exit Scam” and a crypto-currency startup called Confido is a prime example of it. According to CNBC, the founders disappeared with $375,000 with no trace to be found.
Another aspect of the vesting period is that the investors and founders believe in their project and are ready to lock their liquidity for a defined period to ensure price stability.
- Deflationary Tokens
A crypto-currency, or in fact any currency, loses its value if its supply exceeds its demand. In this case, a deflationary token model is adopted in smart contracts.
In this model, the token creators remove the tokens from the market by destroying them in various ways, including token buy-backs and burning of tokens with each transaction.
While the principle behind deflationary currencies is to avoid the market from being flooded by excessive tokens and does sound legitimate, It really isn’t!
In fact, there are quite a few examples in the crypto market that instead of making such tokens more valuable, it has distressed many cryptocurrency projects.
For instance, Bomb Token was amongst the first to initiate the trend of Ethereum-based deflationary tokens. The supply of such tokens will run out by 2034 as on every transaction, 1% of tokens used gets destroyed. Such projects have failed to maintain their value over time. The reasons behind such drastic impacts are the lack of proper adoption, lack of liquidity, and the fact that the majority of its supply is held by the owners.
While there isn’t a clear goal that deflationary tokens offer, they are often associated with the airdrop or Ponzi schemes.
> Airdrop scam describes when scammers persuade users to give away free tokens in exchange for sensitive personal information that can be used later.
> Ponzi schemes are one of the most popular and easy-to-detect types of fraud nowadays. Investors are promised a high rate of return with less risk at a later point in this type of scam. As a result, owners frequently manipulate funds for personal gain.
That being said, the concept of a deflationary token is quite revolutionary as it works as a motivation for people to hold their crypto in the hope of getting a higher return due to deflation. Therefore, a deflationary token is not bad, there can be a bad implementation that one should identify.
- White Paper Plagiarism Scam
Examining a project’s white paper is something that should never be taken lightly. White paper plagiarism scams attempt to mislead investors by copying and pasting the whole white paper of a promising product and launching it under a different name.
As far as smart contracts are concerned, their open-source characteristics have lured the developers to create contract clones. Since smart contracts are not free from vulnerabilities, these plagiarised contracts would acquire vulnerabilities from the original source.
Therefore, betting your money on a great idea is just the half part. The other half of this is making sure that the team behind the idea is the original team or not.
- Honeypot Crypto Trading
A bait to induce investors, also known as a honey pot, is a trap set by providing the users an opportunity to earn some crypto funds. While users see this trap as a method to make money, scammers take advantage of it by seizing all of the money.
This scam is usually executed by employing honey-pot smart contracts that try to fool users by exploiting their greediness.
For instance, a user sends additional funds to exploit a loophole. However, the attacker traps the user and retrieves all the funds.
Therefore, for a user, it should be the number one task to not give in to the temptation of easy money and thoroughly establish the credibility of the contract they are investing in.
- Pre-mining Scam
Another scam that one should avoid being a part of is the pre-mining scam. This scam is an act of awarding founders and promoters with additional coins at the time of ICOs. It is primarily done when the founders don’t burn the unsold tokens. These parties can further manipulate the token’s market since they would hold a significant portion of the tokens.
If these tokens have a vesting period(as mentioned in point 1) then they become a safer option. Otherwise, the price of the token is subject to the will of the founders.
With so many risks, scams, and vulnerabilities, there are also several ways that one can use to keep their investment secured. Reading the whitepaper thoroughly, asking questions about the content and concept of the ICO or smart contract, and double-checking the information are some strategies that can aid in the identification of the right contracts.
Others include verifying the team behind the idea, track record of the team members, audit of the contracts, and future implementations of the project outlined in its roadmap.
In a nutshell, smart contracts are the heart of the Blockchain and DeFi world which is why it is absolutely necessary that complete due diligence be carried out by the users for the risk assessment of these contracts.
Reach out to QuillAudits
QuillAudits is accomplished in delivering efficient smart contract audits. If you need any assistance in the smart contracts audit, feel free to reach out to our experts here!
Follow QuillAudits for more updates