DeFi is the latest trend to emerge in the global financial market as a digital revolution of economic systems. In DeFi, people can lend, borrow, stake, trade, and make investments without the intervention of a traditional financial provider through the use of smart contracts and blockchain. Although this revolution provides multiple benefits, such as access and openness, more dangers within the security realm exist that investors must avoid.
The Decentralization Dilemma
DeFi is a double-edged sword on most fronts due to its very structure. Decentralisation suppresses the need for intermediaries such as banks or brokers, removing the power from the users. Such institutions that are centralised have the necessary buffering. When they do not exist, there is no deFi, a type of decentralised finance which operates far from any systematic control and has little to no consumer protection measures in place. This lack of oversight opens up a few different types of risks, such as intelligent contract exploits and even hacking and fraud.
Smart Contract Vulnerabilities
Smart contracts provide DeFi with the foundation of decentralised transactions and self-executed contracts. However, these contracts are not perfect, and they are subject to some critical issues like smart contracts entail codes, and if there is any bug in the code, hackers are likely to develop ways of exploiting that weakness. A recent fraud of the DeFi protocol bZx, which was attacked by hackers in early 2020.
To manage this risk, it is essential to carry out due diligence when again interacting with any DeFi platform. Select the hard-wired platforms that were vetted by third parties and have demonstrated a strong security profile.
Hacking and Exploits
A significant concern is the fact that the DeFi industry is relatively new and highly decentralised, which makes it relatively easy for hackers to access and attack. Due to these hack attacks, such as phishing scams, flash loans, and rug pulls, DeFi protocols suffered more than $1 billion in 2021. Internal theft, for example, is evolving into an even more frequent phenomenon, i.e. flash loan attacks. These attacks enable the hackers to leverage funds from a system without needing any guarantee, exploit markets and expropriate liquidity from a protocol in minutes.
To mitigate your risk, do not invest large amounts of capital in DeFi platforms. This involves using cold storage, specifically hardware wallets, and only transferring funds when needed.
Rug Pulls and Fraudulent Projects
Rug pulls are one of the dangerous risks in Decentralized finance. In a rug pull, developers catch on to a new DeFi project, attract money into it, and then disappear with all the cash, leaving investors with virtually pointless tokens. These scams are rife in yield farming and liquidity mining platforms due to the high revenue-making hype they often present to investors.
To prevent rug pulls, the best advice is to support projects developed by strong DeFi communities and whose developments are transparent. Do not invest in projects that you stand to gain hugely from or those that are managed by teams with no identity visible online.
