Understanding DeFi Risks
A comprehensive guide to potential risks in yield farming and strategies to mitigate them
Smart contracts may contain vulnerabilities or bugs that can be exploited by malicious actors. Even audited contracts can have undiscovered vulnerabilities, potentially leading to the loss of deposited funds.
- ✓Choose protocols with multiple third-party audits
- ✓Look for protocols with bug bounty programs
- ✓Consider DeFi insurance products for smart contract coverage
When providing liquidity to AMMs, the value of your deposited assets may change compared to simply holding them. This happens due to price divergence between the paired assets in a liquidity pool.
- ✓Choose stable pairs (like stablecoin pairs) to minimize volatility
- ✓Use protocols with impermanent loss protection
- ✓Consider if farming rewards outweigh potential impermanent loss
When borrowing against your crypto assets, significant price drops can trigger liquidation of your collateral, often with additional penalty fees. This can result in substantial losses beyond market movements.
- ✓Maintain a healthy collateralization ratio (higher than required)
- ✓Set up alerts for when your position approaches liquidation
- ✓Have additional collateral ready to deposit in case of market volatility
Cryptocurrency markets are highly volatile. Significant price drops of the assets you're farming can outweigh any yield earned, resulting in a net loss when measured in fiat value.
- ✓Diversify across different protocols and strategies
- ✓Consider stablecoin farming to reduce exposure to market volatility
- ✓Have a clear exit strategy before entering a position
Risk Severity Classification
| Risk Type | Severity | Description |
|---|---|---|
| Smart Contract Risk | High | Can result in complete loss of funds through exploits or bugs |
| Oracle Manipulation | High | Price feed manipulation can lead to draining of funds or unfair liquidations |
| Liquidation Risk | Medium | Can lead to loss of collateral, but typically with some warning and preventive options |
| Impermanent Loss | Medium | Usually gradual and often offset by trading fees and rewards |
| Market Risk | Medium | Affects overall value but doesn't typically result in total loss |
| UI/Front-end Risk | Low | Usually detectable with proper verification steps |