Numerous instances showed us that while there are fantastic chances for gains in the DeFi space, there are also several risks that must be respected.
The Decentralized Finance space had significantly expanded over the last few months, to the point where more than $9 billion worth of crypto assets were secured in its protocols before crypto prices began falling. Space had a scarce over $500 million locked in back in September 2019.
This rapid increase in the last few months resembles to be linked mainly to a yield farming course that commenced when the lending protocol compound started issuing its COMP governance token to users who associated with the protocol.
Simply put, liquidity farming (yield mining) — enables DeFi users to create rewards with their cryptocurrency holdings by associating with protocols that share governance tokens. Liquidity mining can be a profitable venture on its own, but the tokens being farmed often see their price surge as well.
One of many instances of this is YFI, the governance token of Yearn.finance, a site that assists users in finding the best yields in DeFi protocols. Just a little over a month, YFI has increased more than 400%.
The uncertainties of pursuing short-term gains
Liquidity mining isn’t simple as it may sound, nevertheless, and rewards seldom go up in a straight line. It’s also not a practice that’s proper for all crypto holders since it commonly entails holders to guarantee large amounts of capital to earn more rewards. Furthermore, in the decentralized finance space, various risks aren’t immediately apparent.
One risk linked with liquidity mining is that most people seem to overlook is the very nature of smart contracts. Popular DeFi protocols are developed by small teams with limited resources, which can increase the risk of smart contract bugs and vulnerabilities. Even well-known audited protocols have been hacked.
The smart contract risk is genuine and could end up costing a lot of people money. One famous case is that of Yam Finance (YAM), a DeFi project that saw users lock in over $500 million worth of crypto assets on it before a bug that was discovered made it impossible for the community to reach a quorum.
Whereas the authors of Yam Finance did advise users that their smart contract was not audited, the pursuit of short-term gains saw users lock in over half a billion dollars in it — even though the protocol’s token was not listed on top exchanges — before tragedy struck.
As data reveals, after the YAM token hit its high, it crashed from around $100 to $1 in a single day. And the tickets are now worth $0.02.
Additional hazards are related to the inherent volatility of cryptocurrencies and the intentions of those behind DeFi protocols. SushiSwap, a popular decentralized exchange modelled after leading DEX Uniswap, is a pure example here.
SushiSwap is an exchange that does not work with an order book but with an automated market-making, or AMM, model. This model sees liquidity providers add funds to liquidity pools. It differs from Uniswap thanks to the SUSHI token, which entitles holders to the project’s governance and rewards them with a portion of the fees traders pay.
It was conceived by the pseudonymous developer Chef Nomi and in just over a week, saw users lock over $1.27 billion worth of crypto assets in Sushi contracts. Chef Nomi, however, decided to cash out a stake of SUSHI tokens for over 38,000 Ether (ETH), leading some to believe it was an exit scam.
The outcome was a price drop of over 70% for SUSHI, which fell from over $5.3 to $2.3 in less than 20 hours.
Our obligation to DeFi’s viable growth
Chef Nomi closed up giving his admin keys to FTX CEO and Sushi investor Sam Bankman-Fried. They worked on the protocol before announcing he was transferring it to a multi-signature format so no single entity can control the platform.
I offered to help in a bid to support the development of the DeFi space.
There is also a better, more sustainable way of gaining exposure to the wonders of DeFi while ensuring you don’t lose all your money to a bug or human error.
Diversification is essential
Investors very often advise diversification because not “putting all your eggs in one basket” helps ensure you don’t lose everything to scams, unexpected market moves or technical issues, and invest in likely gems while it’s still early.
The elements of a DeFi portfolio are up to individual investors. Preparing your research is highly recommended before investing in any crypto asset — or any asset for that matter.
A portfolio that invested only in some of the most significant DeFi projects and Ethereum would have likely been affected by YAM’s collapse and the SushiSwap situation but would also benefit from YFI’s growth.
To assist you in creating a portfolio that will let you gain exposure to DeFi, OKEx has created a DeFi tokens tab where you can now access 35 different tokens compared to other protocols.
Users can also margin and swap trade a diversity of DeFi tokens on the OKEx platform, enabling them to execute strategies to maximize profits while hedging their trading risks.
All these various tools allow traders and investors to take benefit of the gains to be had in this growing space while guaranteeing that any unexpected event doesn’t see them getting smashed.