In 2021, over US$1 billion was lost in DeFi scams. So, how safe is DeFi really? How should you go about investing in it?
As of 2022, crypto assets worth US$120 billion are locked in decentralized finance (DeFi) applications. DeFi’s rise to fame can be attributed to its decentralized take on traditional financial services, including lending and borrowing, insurance and interest-bearing accounts. As is the case with most things related to blockchains, DeFi sets itself apart from traditional services by having no middleman. Instead, smart contracts run the show, thus eliminating any significant (and sometimes unjustified) intermediary costs.
Utopian as it may sound, DeFi is not flawless. While it removes middlemen from traditional financial services, DeFi projects do not always provide the safety (read: insurance covers) that traditional ones offer. In fact, in 2021, a total of US$1.3 billion was lost to DeFi scams.
With great self-governance comes great responsibility and, often, greater risk. Here, we look at how safe DeFi is and if it’s worth investing in.
Is DeFi safe?
While DeFi prides itself on providing anonymity to users and increasing efficiency by removing the multiple layers of financial institutions, the jury is still out on its safety. A finance professor at the University of Texas at Austin, John Griffin, warns, “DeFi has risks, and in particular could malfunction in ways that we can’t predict. That could lead to financial fragility in ways we also don’t expect.”
Still, DeFi projects do offer great anonymity. Along with that, since all transactions are recorded on the blockchain, there are fewer odds of any tampering. Trust in a DeFi project is built within the community. People work with each other directly, thus not relying on any third-party to navigate their financial decisions.
That said, the platform is vulnerable to bugs in the smart contract, which is a self-executing agreement that forms the basis of DeFi projects. Additionally, investors can become targets of a range of crypto crimes, including rug pulls, phishing and even honeypot scams, such as the Squid Game crypto fiasco.
To keep yourself safe in the DeFi space, use audit tools, like Token Sniffer for Ethereum, to check the smart contract for bugs. Plus, it would be better to opt for open-source projects so that you can see the code and rest assured that any abnormalities will be pointed out and fixed.
Is it worth investing in DeFi?
DeFi became popular for its promise of autonomy. It removed human involvement in financial services, thus reducing the chances of error. It provides cheaper access to capital and gives you a chance to make significant profits. Indubitably, DeFi investments can prove extremely profitable, if you can digest the risk that comes with it.
Despite its claims of “self-governance”, small groups of stakeholders (or holders of “governance tokens”) could change the rules of the DeFi project, and it might not be in your favor. Moreover, there are no shock absorbers (like banks) in DeFi. It means that if you lose all your money, you are not protected or assured of any returns or a safety net.
If you want to get started with investing in DeFi projects, prioritize research and a thorough check of the smart contracts and codes associated with them. You could start off by investing in some well-known and well-performing decentralized applications (dApps), such as Uniswap (which has a market cap of US$6.42 billion at the time of writing this article).
DeFi is still a new development in the crypto space. As it expands (read: DeFi 2.0), the risks might, too. That’s why there is a need for a regulatory framework to support DeFi projects and protect investors.
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