In the evolving landscape of Decentralized Finance, we’ve gathered insights from industry experts including a Head of Decentralized Finance and a president, to address potential pitfalls. From mitigating smart contract risks to overcoming DeFi tax challenges, discover the top four strategies these professionals recommend for navigating the risks in DeFi.
- Mitigate Smart Contract Risks
- Guard Against Social Engineering
- Navigate Lack of Regulation
- Overcome DeFi Tax Challenges
Mitigate Smart Contract Risks
The biggest risk in DeFi is smart contract risk. No matter how often a contract has been audited, it’s never 100% safe, and there’s always the possibility of losing all funds to a hack or exploit. To mitigate this risk, consider these three crucial rules.
Firstly, the Lindy effect, which is the idea that the longer a protocol has gone without a hack, the less likely it will be hacked or exploited in the future. Prioritize older code that’s been around for more than two years. Secondly, don’t get greedy. Yield is directly correlated to the risk of losing funds; act accordingly and make sure you understand all the risk vectors. Lastly, cover your ass by utilizing on-chain insurance (which does exist) wherever possible. This can cover you in case of a hack or exploit.
By keeping these in mind, you can drastically decrease your chances of losing money in DeFi.
A bonus rule is: don’t go it alone. There are plenty of DeFi experts who can help companies outline the risks and rewards of any strategy. Don’t expect your current employees to learn DeFi; bring in an expert who has seen it all.
Head of Decentralized Finance, CryptoOracle
Guard Against Social Engineering
Just like with pre-DeFi, companies need to be particularly vigilant about social engineering, which DeFi is not immune to. But what is social engineering? It’s a method hackers use to deceive and establish trust with a person so that they can obtain the credentials necessary to break into a system or use the person’s identity. That can be scary.
Obviously, in the DeFi world, we want to avoid that, particularly when there is a lot of money on the line. While there are certainly advantages to DeFi versus existing technology when it comes to security, companies can’t be complacent and must ensure that all personnel take courses to ensure they do not fall prey to hackers.
Founder and Managing Lawyer, Substance Law
Navigate Lack of Regulation
Decentralized Finance (DeFi) has been gaining a lot of attention in recent years due to its potential to disrupt traditional financial systems. It offers users the ability to participate in financial activities without the need for intermediaries or centralized authorities. While this presents many opportunities, it also comes with its fair share of risks, especially for businesses looking to integrate DeFi into their operations.
One of the main risks in DeFi for businesses is the lack of regulation and oversight. Unlike traditional financial systems, there are no governing bodies or regulatory frameworks in place to protect businesses and consumers in the event of fraud or malicious activities. This means that businesses will have to rely on self-regulation and due diligence when participating in DeFi activities.
Another risk is the volatility of cryptocurrencies, which are often used as the underlying assets in DeFi protocols. The value of these assets can fluctuate significantly, leading to potential losses for businesses if they are not careful with their investments. Additionally, the lack of liquidity in some DeFi markets can also pose a risk, as it may be difficult for businesses to exit their positions quickly in times of market uncertainty.
Furthermore, the smart contracts used in DeFi protocols are not immune to bugs or security vulnerabilities. This can result in the loss of funds for businesses and their customers if these issues are exploited by malicious actors. Businesses must conduct thorough due diligence on the protocols they plan to use and implement proper risk management strategies to mitigate this risk.
Founder & CEO, Kind House Buyers
Overcome DeFi Tax Challenges
Tax collection and reporting are challenging in the DeFi space. Transactions with digital currencies are subject to taxes, yet reporting them is tough, especially since DeFi largely operates on permissionless and pseudonymous blockchains. Barclays even estimated that the IRS might be losing around $50 billion annually in crypto taxes due to the difficulty in tracing crypto transactions for tax collection.
In DeFi, enforcing taxes is problematic because there aren’t intermediaries equipped to handle tax enforcement, confirm identities, and then submit necessary tax documents like 1099 forms or capital gains notices to the IRS. Even for those who intend to comply fully, the process is inconvenient.
There’s a possibility that software might be developed in the future to help calculate crypto taxes, aiding those who wish to self-report. However, it’s currently easy for individuals to evade crypto taxes, which gives a significant advantage to the DeFi sector over traditional finance, where taxes are more rigorously collected.
President, Croak Capital
