WhaleFarm Crash Is Latest Too-Good-To-Be True DeFi Collapse

(Bloomberg) -- On Monday, something called WhaleFarm was trading above $200 on crypto exchanges. By Wednesday, it was worth close to zero.

It's the latest easy-come, easy-go DeFi project to raise eyebrows, after its crash likely wiped out millions in value in a matter of hours, prompting Twitter lamentations on its obliteration and warnings from market pros on avoiding too-good-to-be true investments.

“The whole thing is just fake -- people get fake yields, they get fake balances and then eventually the founders just take everything. A competitor platform is offering 10%, so I say I can get you 20%. You send me your money and then I run,” said Stephane Ouellette, chief executive and co-founder of FRNT Financial. “All the platforms are perpetuating this stuff because it trades actively, but there is just so much junk and this is only going to continue to get worse.”

WhaleFarm was likely what's known as a rug pull, a malign move that's becoming more prevalent in the DeFi space whereby a developer abandons a project and absconds with the funds. In other words, the holder of the cryptocurrency in question dumps their stake all at once, leading to a catastrophic price drop that wipes out other investors.

Here's how it might play out, according to Wilfred Daye, chief executive officer of Enigma Securities: A token developer copies an existing smart contract code off a public venue and then issues a platform token. The developer then markets it, lists it on a decentralized exchange, and attracts higher-value coins like wrapped Bitcoin or Ether in what's known as a liquidity pool. The developer then sells or redeems their platform token, depleting the liquidity pool of the project. They can then make off with the proceeds.

“Obviously, investors need to be vigilant about such DeFi products. There are always tell-tale signs,” including promises of sky-high returns, copied codebases, and anonymous teams, said Daye.

WhaleFarm is just one of the latest projects to attract attention after the DeFi Titanium token earlier this month in one day went from being valued around $60 to $0 -- something that's considered a rare feat even for the famously volatile crypto space. Renowned mogul Mark Cuban had invested, telling Bloomberg News that though it represented a small percentage of his crypto portfolio, the wipe-out “was enough that I wasn't happy about it.”

DeFi apps are designed to let people lend, borrow, trade and take out insurance directly from each other, without use of intermediaries such as banks. Many essentially let users lend out their coins to new users and to earn returns on the loan -- though yields can also fall if there aren't fresh users clamoring for the coins.

DeFi coins gained popularity this year to become one of the hottest sectors in an already volatile market. But the space -- though it's been plagued by hacks, fraud and a copy-and-paste coding culture -- has come crashing down, in tandem with a retreat in the wider cryptosphere that's seen Bitcoin's year-to-date gains diminish to about 20% from as much as 115%. The DeFi Pulse Index is down roughly 60% from a recent high, according to CoinMarketCap.com. Meanwhile, Bloomberg recently reported, the number of new DeFi user accounts opened daily has dropped to the lowest levels since the embryonic sector started hitting its stride in September.

“The DeFi stuff in general, they pay huge yields but there's massive currency risk,” said Justin Litchfield, who is the Austin, Texas-based chief technology officer at ProChain Capital, a crypto hedge fund.

And so-called rug pulls are not exactly new -- they're just catching more investor attention after huge run-ups for many DeFi tokens. A report from CipherTrace showed the maneuver was one of the top exit scams. In the second half of 2020, almost 99% of major fraud stemmed from rug pulls and exit scams, the company said.

To FRNT's Ouellette, it's reminiscent of what happened during the initial coin offering (otherwise known as ICO) boom in 2017 and 2018, which saw investors lose billions when the bubble burst. In rare cases, some were able to retrieve their investments. “But when people are running away with the money, I doubt there's very much anyone can do,” he said.

Aaron Brown, a crypto investor who writes for Bloomberg Opinion, said that not all the facts are in about WhaleFarm -- the team could, after all, reveal itself tomorrow and pay back all the money. But “while this is a sad story for the victims, it's not a big deal. $2 million frauds are everyday occurrences,” he said. “If the crooks aren't doing them in crypto, they're selling fake stock, or worthless gemstones, or phantom gold, or real estate they don't own.”