ZoneBitcoin EditorialGenerally speaking, we agree that lending (i.e. lending your cryptos and generating interest) is a great option for make money with cryptos.
That said, we are going to talk about risks here, because there are some even if we tend to forget them.
But before you start, be aware of the risks. You will see in this article what the risks are but also how to avoid them.
Impermanent losses
Well, this is perhaps the best known risk of DeFi and especially of Yield farming strictly speaking.
We speak of an impertinent loss when the price of assets deposited in a liquidity pool changes and then creates a (non-effective) loss. Basically, if the liquidity provider had simply kept its tokens, then it would have earned more (at a fixed exchange rate like stablecoin). For what?
Well, this is because pools maintain an asset ratio. If you deposit an amount, you have a share of the total pool amount. When you want to withdraw we give you the share of what you deposited. This can then vary and contain less of a certain asset and more of another for example.
Besides, there is impermanent loss regardless of whether the price goes up or down… This is what makes impermanent losses almost inevitable.
👋 You can access a impermanent loss calculator here and predict your possible losses.
In addition, the variation in the price of the asset can lead to more or less significant losses. Generally, however, this can be offset by paying a portion of the transaction fees that take place on the pool. For example, on Uniswap, the fixed trading fee is 0,3%. They are then donated to foliquidity providers (LP).
Note: The best option to reduce impermanent losses is to provide liquidity containing less volatile assets (typically stablecoins.)
Flash loan attacks
Flash loans are a type of unsecured loan that is truly unique to DeFi. In the bank loan model of classical finance, we see two things:
- Unsecured loans: In general, these are small amounts borrowed less than €10,000 for example. The bank does not require any special guarantee.
- Guaranteed loans: This is for larger sums and typically the bank will analyze the borrower's entire financial history. We only lend if the borrower can repay (salary verification, etc.). We can also ask for guarantees such as mortgages for example.
Unsecured loans are called “flash” (instant loan) in the defi because there is no collateral. How does it work? A borrower can receive thousands of euros in assets without providing collateral but then must repay the entire amount in a single transaction.
This goes completely against the grain of loans which operate on over-collateralization.
There, you need for a flash loan, in a single operation which consists of:
- Borrow a certain amount of an asset
- use this capital to purchase an asset on a DEX (a decentralized platform)
- there, you have to resell this asset at a higher price on another DEX
- Pay your debt with interest of course
If the loan is not repaid, then the lender can cancel the transaction. There is no limit to the amount a lender wants to borrow.
There have been a lot of scams and attacks with this system. People have borrowed huge sums of money to subsequently manipulate the market. They also took advantage of exploiting protocols for their own profit…
In short, you know the scammers in DeFi…
The Rug Pull…
The rug Sweater is the threat that DeFi users fear the most. There have been so many scams of this type that we have all become increasingly suspicious...Rug pull consists of indirectly emptying liquidity pools. People who deposited end up with tokens that are worth nothing…
The first time we heard about Rug Pull was with the chef Nomi who siphoned off SushiSwap with a similar attack called vampire attack...It was a very painful moment in DeFi and it heralded the era of food tokens...
That's a big red flag. When you see that only a few wallets control a large part of the circulating supply, then you should be wary.
You can check on Etherscan (for projects on Ethereum) – by clicking on the “holder” tab under a displayed token. So, yes, yes, developers are now creating different wallets to disperse funds…
A study published in November 2021 indicated that almost half of the tokens created on Uniswap were scams.
Honeypot Scams
These are tokens that attract bees because the price continues to rise without anyone seeming to want to sell them. It is of course suspicious when a crypto that continues to increase in value, and it is even more suspicious when the token in question has no use.
In fact, as with the Squid Game project, users cannot even sell their tokens. This explains why this token is not experiencing a decline. In short, the founders of squid game broke with the millions of dollars raised. Now they are on a yacht most likely enjoying their dirty money.
Phishing attacks
This is a known and widespread scam even outside of cryptocurrencies, it’s a fact. This nevertheless hits the DeFi sector very hard. This involves using an address similar to an official address so that people click on it. This could be a fake form, connection to Metamask who asks you for your private keys (YOU SHOULD NEVER GIVE YOUR PRIVATE KEYS).
False ads...
Whether it's anonymous YouTube channels, Twitter accounts, new influencers on TikTok, there are a lot of fake projects being promoted. Sometimes, influencers and the media aren't even aware of it because everything looks "clean".
This is perhaps what is most confusing. Scams have every viable project… This is what makes it difficult to spot them.
Bad airdrops
Crypto airdrops consist of distributing tokens for free to new members of a community. In this type of scam, the tokens sent to your wallets are fake. They are not tradable because there is no liquidity.
What to do to reduce risks and scams?
According to the security company CertiK, more than 1,3 billion dollars have evaporated into the pockets of scammers of all kinds, in 2021 alone.
Fortunately, now it has become common practice to display the logos and certificates of verification agencies. This can reduce risks greatly because these agencies check the quality of computer code.
That said, even a secure protocol does not protect us from crooked founders, unfortunately. Many audited programs were also scams…
You must therefore always be very careful:
- ALWAYS check the credibility of the team and its background. Ultimately, we no longer want to invest in anonymous projects... We will talk to you about this in another article. It has become too risky given the number of crooks who recycle themselves into cryptos (see Wonderland)
- Read the project and the white paper carefully.
- Check if the project code has been audited by a recognized agency.
- Be aware of red flags like indecent APYs…
We remind you that we can use services in decentralized finance on centralized platforms. There are risks but always lower because the companies are legally registered and we know the identity of the founders. These remain "normal" companies of everyday life.
Thus, there are similar services on centralized finance such as on sites like youhodler for example who make you earn 12% interest on your stablecoins or 4% on your bitcoins. By depositing Stablecoins, you limit the risk of volatility and by going through a CeFi company, based in Switzerland, you are dealing with a regulated company.
CeFi means that it is not classic finance but it is not entirely decentralized because it is the company that manages your portfolios.
Users generally use DeFi platforms but also CeFi to mitigate risks.
Note: No financial advice is given in this or any other article on zonebitcoin. This is information of which you are the sole judge and master. Be responsible with your investments and only invest as much as you are willing to lose.
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