Welcome to Module 7 - Course 2 of Mission Web3!
Now that we’ve established the fundamentals of DeFi, it’s time to take a closer look at the risks and rewards in the DeFi space.
Understanding DeFi Risks
Smart contracts are the foundation of DeFi, but they are not immune to vulnerabilities. Smart contracts are transparent and immutable, but bugs, malicious intent, and other deficiencies in smart contracts can still cause financial losses.
For example, a malicious contract can repeatedly call another contract to drain funds or disrupt its normal operation. The No.1 priority is to stay cautious and alerted when interacting with new or unaudited contracts.
There’s also the liquidity risk when interacting with DeFi protocols. When there is insufficient liquidity in a pool, your positions to enter or exit can be affected. It's important to assess a protocol's liquidity before participating.
Embracing DeFi Rewards
You might wonder, given the risks mentioned above, why do people still engage in DeFi?
The answer is simple: the greater the risk, the greater the reward.
Yield Farming: Yield farming involves providing liquidity to DEXs and earning rewards, often in the form of governance tokens. These tokens can be staked or sold, generating additional income.
Staking: Many DeFi projects allow users to stake their tokens in exchange for rewards. Staked tokens are often used to secure the network and participate in governance decisions.
Lending and Borrowing: DeFi lending protocols allow users to lend their assets and earn interest, while borrowers can secure loans without going through traditional banks. This opens up financial opportunities for individuals who may not have access to traditional banking services.
In addition, DeFi is accessible globally to anyone with an internet connection, making it a revolutionary force for financial inclusion. Individuals in regions where traditional banking infrastructure is limited or inaccessible can now participate in global financial markets, potentially improving their economic prospects and providing more liquidity.
International transactions are also made much easier. DeFi's borderless nature enables cost-effective and swift cross-border transactions. Users can send and receive funds internationally without the need for traditional banking intermediaries or high fees.
Here are a few general pieces of advice on how to minimize risks:
Look for DeFi protocols that have undergone professional security audits. Audit reports are often publicly available and can provide insights into the security of a smart contract.
Consider the reputation and transparency of the development team and the project's community. Communities that actively monitor and discuss potential risks are often more secure.
When experimenting with a new DeFi protocol, start with a small amount of funds to minimize potential losses in case of unforeseen issues.
Keep up to date with the latest news and developments in the DeFi space on channels like Discord, Telegram, and more. Follow security experts and participate in community discussions to stay informed about potential vulnerabilities.
By understanding common smart contract vulnerabilities, conducting due diligence, and adopting best practices, you can significantly reduce the risk of encountering smart contract-related issues and enjoy a safer DeFi experience.