DeFi protocols are now all over, promising high earnings, and it seems like an unforgivable sin if you don’t invest in this new industry. Don’t be in a hurry though. High earnings of the DeFi sector hide serious risks, including smart contract vulnerability, dependence on Ethereum, volatility and regulatory ambiguity. DeFi users who invest their funds in these protocols have a hard time recognizing this fact. We have reviewed systemic risks of decentralized finance (DeFi), whether investing in this sector is safe and what advantages UMI has over it.
What is DeFi?
Decentralized finance or simply DeFi are blockchain-based financial instruments, services and apps. Just like UMI, DeFi aim to create a decentralized financial system as an alternative to the conventional banking sector. In this system, any user can employ financial services without resorting to banks: take out a loan, make a deposit, run international transactions, etc. The role of intermediaries is filled by smart contracts — blockchain-based software that automatically settle accounts between users without involving any third parties. It is believed to mitigate risks.
DeFi is one of the major trends in the crypto world this year. Decentralized services and apps generate up to 15 % in annual earnings without regard to the price growth that could reach several hundred percent a year which is really a lot in the context of declining interest rates and continuing recession. Today, DeFi protocols have tokenized $ 11.98 bln — 22 times more than a year ago. It should be noted though that about 90 % of all tokens in DeFi projects are owned by only 500 wallets.
Growth of Funds Locked in DeFi According to Defi Pulse
Most DeFi protocols and apps are based on the Ethereum blockchain — the most popular platform for smart contracts. There are hundreds of decentralized DeFi platforms, such as InstaDApp, BlockFi, Compound, Polymath, Harbour, Uniswap, Bancor. One of the most popular platforms if MakerDAO — a decentralized credit protocol. It can be used to lock ether in the smart contract and issue DAI tokens backed by the locked ЕТН. In simpler terms, MakerDAO acts as a bank where any user can take out a loan against ether, with no documentation or manager approvals. In addition to lending and borrowing, many DeFi platforms also earn on cryptocurrency storage.
Top 10 DeFi Protocols and Locked Value According to Defi Pulse
Security is the DeFi Sector’s Weakest Point
DeFi sector’s key problem is security. Decentralized protocols are attacked by hackers; developers make mistakes, too.
The weakest point of the DeFi protocols is the insecure smart contracts responsible for running transactions. With not intermediary that would verify transaction correctness, users have to rely on the software. If an error occurs, protocols lose users’ money.
This year, several vulnerabilities in smart contracts of DeFi protocols have resulted in losses for users. We will identify the most important cases:
- In February 2020, a hacker used vulnerability in the bZx protocol twice to withdraw ether worth of some $ 975,000. The malefactor duped the price oracle — a specialized software checking whether all terms and conditions of the smart contract are complied with. Again, this software is another soft spot of the DeFi industry. In winter, developers promised they would fix the vulnerability, run a few third party audits of the smart contract, but hackers still managed to find a missed error.
- On September 14, a criminal used an error in code that allowed them to duplicate assets and withdrew coins worth of $ 8 mln from bZx. Following this, the platform’s token lost 40 % of its value. First, the project promised it would make up the losses for its users from the safety fund, but later that day it was able to the stolen funds by tracing the hacker using transaction history in the blockchain. However, it shows yet again that smart contracts of DeFi protocols are still very unreliable.
- In April, a malefactor used vulnerability in the Chinese dForce protocol to withdraw $ 25 mln. Later, he was identified and couldn’t transfer coins to his own wallets so he had to return the stolen funds. Still, the scale of the attack and his ease in running it were impressive.
- In April, users of the Helig decentralized protocol lost $ 48,000 due to the undue hurry on the part of a developer — an anonymous programmer who goes by the moniker Molly Wintermute. The founder of the project ordered protocol code auditing from the well-known firm Trail of Bits. The firm found no errors, but on the very next day after the launch a one-letter typo generated a problem that cost users all their funds. The developer returned the money and fixed all errors, but this case demonstrated yet again that security standards in the DeFi industry are pretty deficient — even a passed audit wouldn’t secures against errors.
- In June, an error in the smart contract shut down the Bancor protocol network.
- In June, a hacker used vulnerability in the Balancer Labs protocol code to withdraw $ 500,000 which caused the token to lose 70 % of its value.
The list could go on and on, but you can see the trend. The industry needs protocol code auditing and insurance against smart contract errors. It’s funny but right now founders of projects have no time for this. DeFi growth is so explosive that developers simply cannot worry about the security of protocols and user funds — they just want to launch their projects while the hype is on about the new industry.
In this rush, even developers of the most tried and tested DeFi platforms cannot guarantee complete security of the code and zero errors. In the long run, however, users will have to pay the price. This problem was highlighted by Vitalik Buterin, the founder of Ethereum. He remarked that DeFi was not the sector where most regular people would want to invest in. Mr Buterin believes that users of DeFi protocols underestimate the risks related to smart contract vulnerabilities.
Risk of Bubble in the Yield Farming Sector
Yield Farming is the major trend in DeFi and one of the reasons for the sector’s rapid growth. The most popular protocols operating this way include: Aave, Balancer, Compound, Synthetix, Uniswap.
The Yield Farming principle is similar to staking, with users earning percentage rewards for holding their coins in DeFi credit protocols (as payment for providing liquidity). The earnings level is impressive — up to 100 % a year. Both creditors who provide coins and lenders can earn a percentage. Quite often, lending turns out to be more profitable than borrowing. This is why: platforms based on Yield Farming use their own (native) tokens to pay users for any actions in the system: locking up funds, taking out loans, voting, bringing in new users, running transactions. The more active the user is within the protocol, the more they can earn. It’s essentially a reward for being active.
Yield Farming resembles a classical financial pyramid — the system exists while new users join it bringing in new funds. One day the flow of new users will stop. In the best-case scenario, we’ll see protocol teams stop giving away tokens and percentage earnings drop significantly. In the worst-case and most probable scenario, most users would lose their funds in paying for the high earnings for those who withdrew their coins earlier.
A graphic example of unreliability of projects based on Yield Farming is the story of SushiSwap that raised $ 1 bln over two weeks. The project’s anonymous developer sold coins worth of $ 13 mln from the developers’ fund thus collapsing the price of the native token. Users wanted to sue the guy but didn’t know how to find him. In the end, he did return the funds, but nothing actually prevented him from falling off the radar with the money unless he happened to be so conscientious.
Volatility Makes DeFi Too Unstable
Volatility (sudden and frequent price change) is extremely high in DeFi project tokens. Since the start of the year, many have seen their price increase multi-fold, for instance, Aave (LEND), Kyber Network (KNC), Bancor (BNT), Synthetix (SNX) and others. However, some of them have also witnessed rapidly declining prices.
For instance, over the first week of September six biggest DeFi tokens have lost over 50 % of their value. CRV, dipping 65 %, was leading the fall. Over the same period of time, MTA, BZRX, REN, AST and WNXM tokens also lost over 50 % of their value while BAL, UMA, KAVA, BNT, SNX, YFI and KNC tokens became 30–40 % cheaper. Over just two days, September 2 and 3, the Hotdog token first skyrocketed from $ 5 to $ 6,200 to then collapse down to $ 0.01. This is some impressive “sustainability”, isn’t it?
Bitcoin also poses a threat for the sustainability in the DeFi sector. If its price grows rapidly, many DeFi traders might withdraw their funds from the protocols preferring a time-proven asset to the hyped-up sector. During ВТС’s recent growth period, some DeFi protocols, such as DAI, HOT, COMP, SUSD and REP, experienced a significant value loss.
Overdependence on Ethereum
Another weak point of the DeFi sector is its excessive dependence on Ethereum and related assets. Almost all protocols in the DeFi sector rely on a single project, thus inheriting most Ethereum problems. Read our article for detailed information about these problems.
Ethereum’s key problem is its scalability. Its blockchain is overloaded, transactions run at a slower rate, fees are growing (on September 1, the size of fees reached its absolute maximum of $ 13.4 per transaction). DeFi makes a major contribution in creating these problems, with hype around the new sector overloading the network that has already been overloaded. All this has a direct impact on DeFi — users have to pay high fees for token transactions and then wait confirmation for hours on end.
Developers have been promising to resolve all issues by upgrading to Ethereum 2.0, but it’ll take a few years to finally launch it. Over all this time, problems with the network of the secondary cryptocurrency will remain unresolved. As a result, it’ll become too expensive and too slow.
To break free of this dependence, DeFi projects must not exclusively rely on ЕТН — instead, they should use a variety of cryptocurrencies to significantly reduce systemic risks, increase liquidity of decentralized finance and make the industry more independent. For now, it’s not happening.
Another type of risks that is not so obvious at the moment is related to DeFi sector regulation. Right now, authorities seem to leave it unnoticed, but it’s probably a matter of time — one day they’ll look at it very closely.
There have been some early signs. Thus, in early September Hester Peirce, the Commissioner of the United States Securities and Exchange Commission (SEC) (“crypto Mom”), said it was about time regulators looked at DeFi and became stricter with the sector. She believes that despite the sector’s decentralized nature many tokens can be seen as unregistered securities. At the same time, absolute confidentiality of DeFi users negatively impacts the ability to control illegal activity. If something goes wrong, SEC won’t know who to sue. This is why users must be able to play on regulated markets and SEC must be able to bring developers and founders to justice.
Bubble Growing on the DeFi Market
The market of DeFi tokens is overhyped. Most tokens only appeared a few months ago, but have already grown by hundreds of percent and have made to the top in terms of capitalization. However, some of them don’t even have a practical purpose.
Explosive growth of the sector stems from the usual greed of opportunists buying native tokens of decentralized platforms to then sell them, rather than the tokens’ internal value. In this context, the bubble is growing and will sooner or later burst. Once the “greed phase” is over, the overwhelming majority of the projects will be devalued — only the most valuable ones will remain active. The problem is it’s hard to say which ones are to stay afloat in advance.
Why UMI is More Reliable and Profitable than Today’s DeFi Protocols
DeFi is a promising cryptocurrency sector that could do a power of good for the world. But right now this market has too many imperfections, and considering it as profitable is still too risky. Until the problems listed above have been resolved, DeFi will not be ready to the mass use.
Today, growing your cryptocurrency via UMI staking is a lot safer. Conditions offered by our cryptocurrency are really generous. Right now, staking can earn you up to 25 % a month, with a promise of going as high as 40 %. Reliable and time-tested UMI staking smart contract protects users from fraudsters while the network’s unique architecture and the project’s economic model shield from inflation. Besides, UMI does not have Ethereum’s main disadvantages which are characteristic of the first-generation cryptocurrencies. UMI has a high network capacity and has no fees or scalability issues.
We would also like to highlight UMI’s key advantages as compared to the DeFi sector, to make it more visual.
- Liquidity and sustainability. Few DeFi projects are characterized by sufficient liquidity. The order book supporting UMI’s current price has over $ 1,400,000 on SIGEN.pro. With the p2p platform, UMI’s overall liquidity amounts to over $ 1,700,000. This “wall” protects UMI price against decline and makes UMI a backed cryptocurrency that can be sold without the risk of a price slump.
- Staking does not require coins to be locked. In DeFi projects, staking locks coins for a long time — up to a year or longer. With UMI staking, you don’t need to lock your coins at all — you can withdraw them at any time while continuing to earn up to 40 % a month. It’s equally important that coins are generated in your wallet, and you don’t have to give them away to anyone, including owners of staking structures. You are the only one to have access to your coins.
- UMI is undervalued. Most experts believe that the DeFi market is overheated and is only growing because of the hype around it. Projects often collapse, with tokens losing almost all of their value. UMI, on the contrary, is a really undervalued project since we’re only starting to gain access to the mass media and have a huge potential to grow in all aspects.
- UMI ensures security for user coins. As you could see, many players on the DeFi market think the here-and-now profit is more important than security. For us, security comes first. Right now, we’re ensuring complete transparency, with the network code accessible to all.
- No fees. You need to pay high and ever-growing fees for all transactions on the DeFi market, including withdrawals. Fees are charged by both the network and the smart contracts. Sometimes, fees account for as much as half of the total amount. DeFi is for the rich, while UMI has no fees at all. Except the fees charged by the staking structures. To be fair, though, these fees are paid off in a few weeks and are spend on MLM bonuses that help develop structures.
UMI is a completely new trend in cryptocurrency. It’s a new development that could change the world. UMI enables instant and free transfers, secure growth of coins at the rate of up to 40 % a month and new innovative solutions. UMI can also be used to create smart contracts with any level of complexity, including DeFi protocols.
Over time, UMI will be used to launch large-scale DeFi projects that will be faster, more secure and multi-functional than the ones based on Ethereum. UMI is a new-generation blockchain platform that is well positioned to achieve success in various areas, including the DeFi sector. We’re confident we can do it.
However, we should move forward step by step. At this point in time, we’re focused on improving system operations and making our cryptocurrency popular. We’re doing just fine. You can read more about our official plans in this article.
Sincerely yours, UMI Team!