Cryptocurrency investments became an instant hit along with the Trading Platform since its launch in 2009, the concept has been gaining attention from new and experienced investors.
Other than individual investments, crypto tokens have also attracted institutional investments. Many companies are funding research and development in the crypto industry.
What made cryptos popular?
Other than blockchain technology, there is another interesting concept of crypto work. Every cryptocurrency runs on the decentralized finance model. This means transactions undertaken on the blockchain platform do not involve any banking agencies. Also, crypto investments do not fall under direct monitoring and governance.
Understanding decentralized finance
Decentralized finance (DeFi) is nothing but the lack of regulatory authorities. Ranging from central banks to tax authorities there is nil involvement of the government in monitoring cryptos. This working model became a huge hit amongst investors. It allowed investors to earn and convert their profits to traditional currency. There were no taxes or charges on such conversions.
The concept or the ecosystem works on a blockchain platform. It allows users with all types of banking services as traditional banks. Users can convert their holdings, trade their holdings or even lend the same over the internet.
The blockchain platform makes use of decentralized applications to enable such services. There is a built-in algorithm within the blockchain platform also known as smart contracts. The contracts are executed when certain conditions comply.
DeFi is one such traditional banking and financial service that is available on the net. Investors can receive interest on savings, liquidate their assets, etc. using this technology.
Additionally, the interest rates offered through these dApps are comparatively higher. Investors gain benefits from their funding through the passive income model.
But, before you dive completely into the DeFi process, let us also look at certain risks.
Risks of governance module
Yes, the DeFi platform has various inbuilt governance modules. The governance module controls the working of a decentralized application in the system. There is an increased risk of centralization of various activities within the protocol.
Risk of flash loans
In the traditional banking system, we come across two types of lending. Unsecured loans are nothing but loans that do not require any collateral. In traditional banking, such loans may not include a huge sum of money. It may range only up to a few thousand. Another type of loan is the secured loan wherein credit is given against collateral.
In the case of DeFi, there is always a risk of unsecured flash loans coming your way. Smart contracts control the environment and lack a complete check on user credibility. The risk of flash loans lies in the way the market gets manipulated.
Risk of rug pulls
Yes, now that everything is on the internet there is a certain level of trust needed. But, rug pull is a situation wherein this trust is lost in the blockchain environment. This is an exit market trend in the DeFi world today. a new token gets created in the blockchain network. This newly created token is then linked to any leading tokens like BTC or ETH. With popular names to credit, investors often end up funding these new tokens. Once funds are accumulated these tokens just disappear from the network.
How to avoid such threats while working on DeFi?
There is no problem without a solution. Now that we have understood the risks of investment, let us also look at possible mitigation plans.
As the first step, ensure you are completely aware. As an investor you need to check the credibility of tokens. Make your investments only if you are sure. Yes, market research and trends are helpful. But trust your instinct before making your funding on any new token.
Check the history of the token you are funding. Look at their audit plans and ensure that a third-party audit is complete. It will enhance the credibility of the token you are investing in. do not fall for unrealistic returns. Yes, crypto is a money-making machine. But do not blindly trust promotions and marketing gimmicks.
Also, as an investor do not push yourself beyond the acceptable threshold. Make your investments only DeFi protocols and tokens that are less risky. Once you gain control over this platform, you may consider making a move into higher-risk tokens.