According to a report published by crypto risk management firm Elliptic, fraud and theft of decentralized finance (DeFi) investments has surpassed $10.5 billion so far this year — that’s a 600% increase over all of 2020. DeFi is an automated method of banking and financing that runs on blockchain-based computer programming. It provides faster, cheaper cryptocurrency transactions anywhere in the world without a finance rep, credit check, or loan officer in the middle. As of this writing, more than $106 billion in funds are currently being invested in various DeFi offerings — that’s up from $12.4 billion invested just a year ago.
Key DeFi weaknesses
The Elliptic report found that the main vulnerabilities of DeFi were programming design errors that produced software bugs that hackers exploited as well as outright theft from “trusted” founders and developers who turned out to be crypto-cons. “Decentralised apps are designed to be trustless in that they eliminate any third-party control of users’ funds,” said Elliptic chief scientist Tom Robinson in an official statement. “But you must still trust that the creators of the protocol have not made a coding or design mistake that could lead to a loss of funds.”
DeFi is not unique in risk exposure
It’s worth noting that as DeFi and crypto in general are only now beginning to come into their own, those technologies shouldn’t be singled out as more susceptible to fraud. Earlier this month, the San Francisco Federal Reserve branch posted a blog on its website that cited a report from Javelin Research which stated that total combined fraud losses climbed to $56 billion in 2020, with identity fraud accounting for $43 billion. Again, DeFi is not unique in its risk, it’s just the latest high-profile target.
“We are still at the experimental stage and DeFi users face significant risks. As the technology matures and becomes better-regulated, losses will fall and DeFi will become a practical alternative to the banks, asset managers, and exchanges that we currently rely upon,” stated Robinson.
DeFi defensive steps to take
By definition, decentralized finance puts the responsibility to manage and protect your money on you. Here are some common-sense steps you can take when reviewing DeFi options:
- Only consider projects that have a proven and published roadmap of progressive upgrades and developments spanning several years.
- Look for DeFi projects that regularly run “bug bounties” where they pay outside programmers and “good guy” hackers to pressure test their computer code to harden it against real threats.
- Only trust projects with founders who have been in the crypto space for years with a good reputation on different ventures.
- Only invest in what you know. If you don’t understand liquidity pools, market makers, yield farming, or other elements of DeFi, stay away until you educate yourself.
Despite the specific DeFi difficulties outlined in the Elliptic research, all investments are susceptible to potential risk, loss, and theft. Whether investing in DeFi, derivatives, or diamonds, your best defense is a balance between being smart and being careful. If you don’t take a smart and careful approach with your investments, your investments are unlikely to be yours for very long.