The risks of investing in a DeFi project

DeFi is a potential financial industry, but the risks cannot be ignored. Lots of people make money there and lots of people lose it. Therefore, to limit the risks posed by DeFi, make sure you arm yourself with the necessary knowledge about this investment. In this article, we’ll cover some of the most serious and current risks to DeFi products.

Not recognized by law

DeFi products and cryptocurrencies are not yet officially controlled by the government. This means when you invest in a DeFi product, if there is a risk, no one steps in to protect the interests of investors like you.

Bitconnect is a good example of crypto investment in Vietnam. Many investors rushed to invest their money here. And indeed almost everything was lost when this “monument” fell.

Risks associated with Smart Contracts

A smart contract is a type of software that represents a traditional financial intermediary such as a bank, financial institution, etc. It helps to record the agreement between the parties. Once the request is fulfilled, it will be executed automatically.

Of course, artificial software also means it can be hacked (hacked) by humans. Hackers can attack by exploiting vulnerabilities left “accidentally” by programmers. You can change the rules there. This affects all DeFi products. And that will definitely hurt most users.

A case in point is Yam Finance’s “Sweet Potato” project. Due to the rush to launch products to participate in DeFi, Yam fell victim to this problem. Hackers find critical errors in logs. The price drop caused the project to collapse immediately. The reason given was that Yam had not conducted a product audit yet.

risk of financial problems

This risk arises from fluctuations in the price of coins used in DeFi products. The MakerDAO scandal on March 12, 2020 is an example. More than 3,000 investors accused the Maker Foundation of losing more than $8 million over its record.

The main reason is the sharp drop in the price of Ethereum. This is the main coin used as collateral in the MakerDAO protocol. This is used as collateral for DAI stablecoin loans. A drop in the price of ETH simultaneously liquidates the thousands of previously guaranteed bonds (CDPs) held by investors.

It is not known whether the case will be successful or not. However, due to the high volatility of cryptocurrencies in general, this is also a risk investors should be aware of.

Liquidity problem risk

This is the term used to describe how easy it is to buy or sell assets in the market. It basically describes how quickly something can be converted into cash.

There are two types of liquidity risk. The first is the liquidity risk associated with cash flows. And the second is market liquidity risk. Typically, market liquidity risk is the most worrisome part of a DeFi product.

Liquidity risk involves uncertainty as to when investors will be able to get out of their investments in a timely and efficient manner. While liquidity is not currently an issue with Automated Market Maker (AMM) protocols such as Uniswap, this may not always be the case.

Fragmentation of liquidity pools between many different protocols can actually lead to low market liquidity within each pool. This can result in significant slippage in a single trade where the price and strike price differ. Or if the user prefers to trade them over a different protocol, the transaction fees are higher.

The danger of centralization

Centralization risk is an important factor to consider when using DeFi products. One of the main factors contributing to the risk of centralization in DeFi products is the use of management locks.

Admin keys allow DeFi developers to modify their system settings such as interest rates, fees, incentives, etc. In other words, the owner of the admin key has the right to change the order of DeFi products. than anytime.

If this did happen, it would inadvertently lose the inherently decentralized nature of blockchain. After all, the ability to freely change the parameters of a smart contract can lead to financial losses for investors.

To remove this focus factor, there are two methods that most of the developers use. It uses timelocks and a multi-signature wallet.

The YFII project itself was also subject to these community concerns prior to its launch. And hence project development team need to burn admin key.

Technology Risk

Risk in technology is a matter of user knowledge. It’s not too hard to get used to the nature of what you use your business for, but it’s fairly new. We often don’t have the opportunity to gain experience in traditional financial markets such as stocks or forex. At this point, you will be a little overwhelmed with concepts like yield farming, providing liquidity, etc.

Despite the potential of DeFi, it may not be for “new players”. Because the DeFi market changes so quickly, what you know today may be outdated tomorrow. So you need to update new news regularly. Or you lose money due to ignorance. Therefore, you must be careful and do your research before entering this market.

Become a victim of a DeFi scam project

2017-2018 was a boom year for cryptocurrency ICO projects. But according to the survey, most of the ICO projects back then were branded as scams. This DeFi wave also cannot avoid “collapse”.

Compared to ICOs, the fraud rate in DeFi projects tends to be higher. Therefore, before entering this market, learn how to protect and recognize the characteristics of DeFi scam projects.

WARNING: Investing in financial products involves a lot of risk and may not be suitable for all investors. Therefore, please think carefully and check yourself before you decide to link to this website. CryptoViet.com.