DeFi Due Diligence? Not that hard

@sergeigorshunov

CEO @ Bitbanker

Credibility

Ready to try out DeFi? Learn how to perform thorough research first!

When it comes to decentralized finance (DeFi), doing your homework is super important before diving into any project, let alone investing in it. To reduce risks, prepare to dig deep into the essence and operations of DeFi protocols and do thorough research. This opinion piece is all about sharing the key steps to level up your due diligence game and highlighting the importance of doing your own research.

Dig deeper: Understand the protocol's essence

A cornerstone of DeFi projects is the white paper, a document that outlines the technical definitions, theories, and operational mechanisms behind a protocol.

When it comes to white paper, look for a thoroughly thought-out and well-balanced paper. A white paper that is well-crafted should offer valuable insights into the purpose, concepts, and operational intricacies of the protocol. The text needs to provide a holistic understanding of the decentralized finance ecosystem and outline the value of the new addition to it.

To grasp the true motivations and objectives of a protocol, it is essential to immerse oneself in the white paper. However, it is equally crucial to discern white papers that genuinely serve their purpose from those primarily focused on promoting governance tokens. A comprehensive white paper should encompass the broader scope of the project's objectives rather than fixating solely on token promotion.

Additionally, one should be wary of white papers that provide only a superficial description of the protocol, lacking detailed information on its real-world implementation. The more complicated the better. Not always. Heavily theoretical white papers rarely raise red flags, however, projects that immerse into the mathematical parts often fail to articulate (or maybe even understand) their mechanisms or operational processes and should warrant caution.

Roll up your sleeves: study project documentation

Unlike white papers, which delve into concepts and theories, project documentation provides specific, detailed instructions on how to interact with and employ the protocol effectively. This part of the project website contains crucial aspects such as protocol overviews, step-by-step instructions, smart contract links, security practices, tokenomics breakdowns, audit reports, and fee structures.

The presence of robust project documentation signifies a project's commitment to transparency and accountability. Conversely, the absence of documentation alongside a functioning decentralized application (dApp) raises concerns about the project's failure or lack of motivation to adequately explain its DeFi application.

To assess the authenticity and reliability of project documentation, it is advisable to check its uniqueness. Plagiarism-checking and AI detection tools can be employed to identify potential scams, subpar project teams, and less serious endeavors.

Genuine projects invest in well-crafted documentation, showcasing their dedication to providing accurate and reliable information. If the decentralized nature of projects is important to you, search for a roadmap section of the documentation. A dedicated team always sets its goals and objectives straight.

Practical advice

• Run the documentation texts through anti-plagiarism programs,
• Run the text through AI detection programs, like ZeroGPT,
• Try and find an editor on the team who is assigned to editing and updating the pages,
• Look for a roadmap.

Unveiling the Guardians: Meet the team

Decentralized doesn’t necessarily mean anonymous or unreachable! The team behind a project plays a crucial role in its success. Knowing the individuals responsible for the project's development and governance is instrumental in verifying its legitimacy. Transparent teams allow users to conduct research on each member, exploring their past associations and reputation within the industry.

Scrutinizing team members' social media accounts and LinkedIn profiles offers valuable insights into their values and beliefs. Teams that primarily focus on promoting their project's token and inflating its price should raise concerns.

Genuine project teams prioritize the product, emphasize the protocol itself rather than the token and demonstrate respect and insightful attitude towards other projects in the sector.

While assessing anonymous teams poses challenges, observing their commitment to core development aspects rather than aggressive token marketing can provide some reassurance. Although the absence of personal history is a limitation, teams dedicated to protocol development often exhibit greater credibility. Remember, that the mighty Twitter may help you find background information even on anonymous builders.

Practical advice

• Locate the project’s team page;
• Try to google the core team members and find them on LinkedIn and Twitter;
• Explore the team members’ background and their level of involvement in current and past projects.

No token, no cry: study the project’s tokenomics

While this could be the most difficult part of your research, tokenomics (token economics) holds immense significance, particularly for projects incorporating governance tokens. It encompasses aspects such as token distribution, emissions, use cases, and economic incentives.

A thorough examination of a project's tokenomics breakdown should provide insights into token distribution, vesting schedules for the project team, community allocations, treasury allocations, liquidity provider incentives, strategic advisor allocations, seed round investor allocations, token utility, and any mechanisms such as token burns, buybacks, or revenue sharing.

A balanced and fair tokenomics model prioritizes the interests of the community and retail investors and contributes to a more sustainable ecosystem. Projects that disproportionately allocate token supplies to insiders and project team members should be approached with caution. The absence of appropriate vesting schedules is definitely a red flag.

Practical advice

• Investigate the allocation and distribution of tokens. Focus on how tokens are divided among different departments, such as marketing and development, as well as the allocation to the treasury.

• Study the supply and emission schedule. Assess the circulating supply, which indicates tokens currently in circulation. Explore the total supply including those created, burned, and circulating. Lastly, examine the max supply, representing the project's maximum token generation capacity. A healthy project displays a steady increase in circulating supply while avoiding excessively rapid or frequent token emissions.

• Learn what market cap really is. Market capitalization acts as a key metric intertwined with token emissions. Projects with higher market capitalization and lower circulating supply may showcase safety and long-term viability.

• The token model is critical in regard to token emissions and the mechanics of token burning. Some projects adopt a dual token model, featuring both a security token and a utility token. Security tokens, such as governance tokens, offer holders the power to influence project decisions, while utility tokens serve as transactional units within the platform.

And lastly, a few DON’Ts when it comes to quickly choosing a dApp to invest in without conducting proper research:

·      Don’t fall for large transaction count numbers. They can be forged easily.

·      Don’t fall for large-volume pools for the corresponding token. The funds in the pool can disappear from there in a blink of an eye.

·      Don’t fall for big-name investors in the list. Remember that big investors also can be mistaken. Do your own research before entrusting any project with your assets.

Bitbanker and its new investment feature is a way to try out all the good things DeFi has to offer with the proper due diligence already performed. The newly developed investing module helps you invest and profit only from the most secure of dApps.