How DeFi protocols can be protected from potential scams

In this article, you will explore about how DeFi protocols can be protected from the ongoing scams targeting the crypto industry.

By · Dec 11, 2020 . 12min read

DeFi protocols of 2020

Lately, the crypto bull rally has resulted in a scammers’ rally too. From ransomware attacks to rug pulls, the crypto industry has seen it all. Certainly, the crypto industry is a growing industry that has seen both peaks and troughs in a quest for wider adoption. Where DeFi players like Uniswap have portrayed the success of the DeFi industry, pseudonyms like Chef Nomi of Sushiswap have taught us how rug-pulls can leave innocent investors helpless.

With a total value locked over $13.6 billion, DeFi is still in its infancy stage compared to the broader digital financial market as a whole. DeFi Protocols like Aave, Compound, and Maker Dao have sparked innovation in the DeFi industry, surpassing people’s imagination with exponential growth and usage. However, with the advent of every new technology, certain loopholes are existent. Hence, newer projects are striving towards enhancing the prevailing technology and its usability.

Different types of scams targeting the DeFi industry

In 2019, the DeFi industry was almost negligible. However, with days rolling by and the inception of protocols like Compound, Aave, Maker Dao, and others, the DeFi industry gained momentum. Since then, it has been experiencing a bullish trend leading to consistent innovation and growth. The crypto community has played a significant role in the DeFi boom. It has participated magnificently to push DeFi protocols to the success where it stands today.

However, the community has had its own share of menace due to the hack-prone DeFi community. DeFi Protocols are permissionless in nature and are available for scrutiny in open-source, public domains. Moreover, the irreversibility or lack of control on the blockchain-based protocols exaggerates the ongoing scenario. Another concern is the interoperability of various DeFi protocols to enhance the user experience, leading to malicious attackers taking advantage of the same. Right from Argent Wallet’s uncovered vulnerability of freezing funds in the wallet without guardians to Chef Nomi of Sushiswap draining $14 million worth of Sushi tokens intended to earn profits through rug pulls, the DeFi industry has been a constant target for malicious attackers.

In October 2020, we saw how Harvest was deeply threatened by hackers who exploited the protocol for $24 million utilizing flash loans by manipulating stablecoin prices in a quest to arbitrage. Furthermore, Compound Finance suffered an oracle attack due to faulty DAI pegged dollar prices drawn by Coinbase’s centralized oracles resulting in hacks swiping away funds worth $100M.

Long-term Solution to DeFi Scams

Notwithstanding the current scenario, DeFi scams have immensely hurt the community. This has resulted in a decrease of the potential hype, specifically after Chef Nomi’s rug pull of the Sushi token. However, Defi remains a significant game-changer in the crypto community. The DeFi community is still actively looking towards innovative products and solutions to set the DeFi ecosystem on fire. However, investors are now more keen on making evaluated and informed decisions, unlike before. 

One of the products striving to lower the scam magnitude is Liquidity Dividends Protocol, popularly known as LID Protocol. This is primarily applicable for avoiding exploitations from “rug pull.” A rug pull is when the smart contract developer or founding team that once incepted liquidity into the DEX to attract potential investors to the project withdraws the entire liquidity at once. This results in a huge token dump in the market. Therefore, cascading the price resulting in severe losses for those invested in the project. This is one of the ways malicious projects dupe investors, thus disgracing the community on the whole. 

Nonetheless, with LID protocol, projects can utilize the attribute of locked liquidity wherein premature cash-in is not possible. The new technology solves the problem of exit scams in a non-custodial way by locking liquidity into the smart contracts. Furthermore, LID also provides Licensed Certification for projects that can help potential investors analyze the project’s viability, authenticity, and security. It provides an added protection layer to investors keen on investing in smaller projects. LID extends its support primarily to ERC-20 tokens in a trustless manner. 

An additional attribute is LIFTOFF. It is a mechanism that allows smaller projects to kickstart their initial funding in an entirely automatic way. It combines time locking along with permanent liquidity locking in smart contracts.

The Road Ahead

Where there are malicious entities in the crypto ecosystem taking advantage of bugs in a project, there are projects consistently trying to overcome wrongdoings to safeguard the ecosystem. Innovation is fueling the DeFi space with various efficient risk management and insurance-based solutions to protect investors’ interests. For instance, recently, Yearn Finance and Cover Protocol collaborated to utilize shared resources to introduce reduced-risk products in the market. However, the decentralized nature of the projects itself exposes potential risks. Although the following words ring true in the case of the DeFi ecosystem, “Informed risks can lead to higher returns.”

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