Decentralized Finance(DeFi) is one of the prominent use cases of blockchain technology influencing how finance works in this new technology-oriented world. In DeFi, users enjoy security, accessibility, and transparency, which this generation needs and look for.
With advantages like interoperability, programmability, immutability, and control, DeFi challenges regular bank-based financial solutions as a promising and better alternative. Still, it would be far from the truth to say that DeFi is completely safe. With full control of your funds, you must use them wisely and secure yourself from the risks. Here we are to discuss a few risks and vulnerabilities you should look for in the DeFi world. Let’s start.
The Protocol itself
When it comes to DeFi, the protocol is the backbone of it. The protocol provides you with the platform for DeFi over the blockchain. It tells the rules of the working and the underlying financial functioning of the platform. AAVE, Compound, and Uniswap are some examples of very well-known protocols.
The risk associated with it can be huge, as blockchain is an open space. Anyone can start their protocol and label it as a trustworthy DeFi platform, but not every such protocol is safe. When going for DeFi, it is almost important to check the financial backing, financial soundness, and financial correctness of the protocol and make sure the one you are investing in does not turn out to be a fraud. This can be done by going through the protocol’s whitepaper or staying confined to well-known protocols.
The Market Risk
No investment or financial move is free of risk. It does not matter whether it’s a regular bank-based investment or finance, the same is true in the case of DeFi, there is always risk involved, and this risk is often related to the financial understanding of the market.
By market, I mean the ecosystem of the DeFI protocols. Different market risks are involved with different types of protocols, and the user should be aware of that before investing to save from losses; this can be done by going through the whitepapers and collecting information about protocols’ working and their underlying financial structure.
Social Attacks on DeFi
Decentralized Finance, the term decentralized itself brings some risks with it. With users becoming part of the working of the protocol, there is a social layer in these decentralized finance protocols, which influences the decision-making of the protocol’s future steps.
This opens up the doors for hackers to manipulate the protocol’s working by infiltrating the protocol’s social layer, which is dangerous for the protocol users.
Smart Contract attacks
The DeFi protocols are fueled by smart contracts, which provide the flexibility and programmability of the protocols. Smart contracts facilitate the implementation of complex financial logic and conditions. But many times these smart contracts can result in the downfall of the protocols.
Over the past few years, web3 space is noticing a continuous rise in web3 attacks which sounds an alarm for more security-oriented development. It is of utmost importance to keep in mind the code quality of the smart contract and ensure that the protocol’s implementation has no vulnerability, which could lead to loss. To confirm and verify the protocol’s implementation and architecture, the protocol team contacts smart contract auditors, which help them tackle and take care of security issues.
DeFi, with promising results, has taken on Web3 quite quickly and continues to expand because of its flexibility and ability to best the existing bank-based financial solutions. But it is of equal importance to keep in mind one’s safety. The users of DeFi need to be very well informed and educated to analyze risks and security issues best. Only by doing so can one fully enjoy the power of DeFi.