The risks of investing in DeFi projects

DeFi is a potential financial industry, but the risk is not small. There are many people who make money from it and many people who lose money from it. Therefore, to limit the risks that the downside of DeFi brings, make sure you have equipped yourself with the necessary knowledge about this investment.

Not recognized by law

DeFi products and cryptocurrencies are not yet officially controlled by the Government. This means that when investing in DeFi products, in the event of a risk, there will be no one to protect the interests of investors like you.

Bitconnect is a good example of a cryptocurrency investment. A lot of investors rushed to put their money into it. And in fact, almost everyone lost everything when this project collapsed.

Risks related to smart contracts

A smart contract is a type of software program that represents intermediaries in traditional finance such as banks and financial institutions. It helps to record the agreements between the parties. When the request is met, it will be executed automatically.

Of course, man-made software also means that it can be hacked (hacked) by humans. Hackers can attack by taking advantage of vulnerabilities left by programmers. They can then change the terms set forth therein. This results in the entire DeFi product being affected. And it will certainly be detrimental to the majority of users.

A typical case is the Yam Finance project. Due to the rush to launch products to participate in DeFi, Yam has become a victim of this problem. Hackers have found a critical bug in the protocol. A price crash caused the project to collapse in an instant. The reason given is that Yam has not conducted a product audit.

Risk of financial problems

This risk comes from fluctuations in the price of coins used in DeFi products. The MakerDAO scandal on March 12, 2020 is an example. Over 3,000 investors have accused the Maker Foundation of over $8 million in damages on their protocol.

The main cause comes from the sharp drop in the price of Ethereum. This is the main coin used as collateral in the MakerDAO protocol. It is used as collateral for loans of the stablecoin DAI. The drop in the price of ETH has simultaneously liquidated thousands of previously collateralized debt (CDP) held by investors.

It is not clear if the case will be successful. However, basically, with the high volatility of cryptocurrencies, this is also a risk that investors need to be concerned about.

Risk of liquidity problem

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

There are two different types of liquidity risk. The first is liquidity risk related to cash flow. And the second is market liquidity risk. Usually, for DeFi products, market liquidity risk is the most worrying thing.

Liquidity risk involves uncertainty when an investor wants to exit their investment in a timely and efficient manner. While currently with Automated Market Making (AMM) protocols like Uniswap liquidity is not an issue, it may not always be the case.

The fragmentation of the liquidity pool between many different protocols can actually lead to a market with low liquidity within individual pools. That can lead to large slippage, where the quote and strike prices differ, in a single trade. Or if users prefer to trade it through different protocols, the transaction fees will be much higher.

The risk of centralization

Centralization risk is an important factor to consider when using DeFi products. One of the biggest contributing factors to centralization risk in DeFi products is the use of an admin key.

Admin keys allow DeFi developers to change the parameters of their system such as interest rates, fees, incentives, etc. Simply put, the holder of the Admin key has the right to change the order inside the DeFi product. that any time.

If this really happens, it accidentally loses the inherent decentralized nature of blockchain. Because, the ability to freely change the parameters in a smart contract can cause financial losses for investors.

To remove this focus factor, there are two ways that most developers use. It is using Timelocks and Multi-signature wallet.

The YFII project itself, before being launched, was also raised by the community with these concerns. And as a result, the project’s development team had to burn the Admin key.

Technological risks

The technology risk is a matter of user knowledge. The nature of what you use for trading purposes is not too difficult to get used to, but it is quite new. Often in traditional financial markets such as Stocks or Forex we have not had the opportunity to experience. At that time, you will feel somewhat confused with concepts such as going to farm (Yield Farming), providing liquidity.

Despite the potential DeFi has, it’s probably not for the newbies. Because the DeFi market changes so quickly, what you know today may become obsolete the next day. So either you will have to regularly update the new news. Or you will lose money because of ignorance. Therefore, you should be careful and learn carefully before entering this market.

Being a victim of DeFi Scam projects

2017-2018 was the explosive year of ICO projects in the field of cryptocurrency. But according to the survey, the majority of ICO projects at that time were labeled as scams.

Compared to ICOs, it is predicted that the scam rate from DeFi projects will be much larger. Therefore, you should learn how to protect and recognize the characteristics of a DeFi scam project before entering the DeFi market.

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