Get a loan from Defi
Suppose you want to get a $ 1,000 loan from Ethereum or Bitcoin while you do not intend or even think about selling your cryptocurrencies. Defi lending platforms are your solution. By using these platforms, you can provide your Ethereum or Bitcoin as collateral like an assurance to the platform for a short time, and you can receive the loan amount. In this case, you have not sold your Ethereum, and better than that, you have provided the money you need.
When we hear Defi’s name in the cryptocurrency market, we think of tens of thousands of profits and countless earning opportunities. However, we must not forget that anything in the investment world that has high profit also has its risks. Defi lending platforms are no exceptions. If you want to learn more about getting a loan from Defi lending platforms, we suggest you read this article.
As you know, Defi stands for “Decentralized Finance.” Decentralized finance is an ecosystem of Blockchain-based applications that provide financial services similar to traditional banks, insurance brokers, and other financial intermediaries.
The difference between traditional financial services and Decentralized applications is that these applications operate independently and without intermediaries. Because the performance of each of these applications, instead of individuals, is based on one or several smart contracts. You also know that a smart contract is a special computer program that automatically executes certain operations if the predetermined conditions are set.
“Lending” is one of the traditional financial services that is possible in the world of cryptocurrencies through these Decentralized peer-to-peer applications.
The creation of the possibility of lending money in the Decentralized world of cryptocurrencies was a great achievement that made these currencies very popular and caused a large amount of capital to enter Defi platforms. But as we mentioned before, in the previous sections, this achievement of decentralized finance, like any other new and emerging phenomenon, is not risk-free and has its potential risks.
In the following, with the help of an article from CoinDesk’s website, we will review three examples of these risks and introduce solutions to prevent them.
3 major threats to Defi lending platforms
Defi lending platforms are, in fact, the Decentralized version of the traditional banks we turn to for Fiat currency loans. Of course, there are fundamental differences between these two; However, their concept and nature are the same.
Cryptocurrency investors, just like the time when they deposit money into their savings accounts to make a profit, now can lock their funds in Defi platforms and use them to provide liquidity to those platforms and receive regular profits.
The interest rates on some of these Decentralized apps are much higher than the fees paid by traditional financial institutions. So, cryptocurrency owners are a passive and attractive source of income (Passive Income).
But do not forget that before lending or getting a loan from any asset, you must consider the risks associated with it and be aware of them. In the following, we will introduce and review some of these risks to you.
When you deposit your assets into a liquidity pool, one of the risks you might encounter is the “volatile loss.” Unstable losses occur when the price of locked-in assets in a liquidity pool changes after a deposit, and an “unrealized loss” occurs.
In other words, if the liquidity providers or the investors kept their assets in cryptocurrency, they wouldn’t be hit by this loss. Asset prices fluctuate or change for two reasons, both of which are inextricably linked to the automated marketing system used in Defi liquidity pools:
- Defi pools hold a certain proportion of assets in the pool. For example, an Ether/link pool may keep the ratio of Ether and link tokens in the pool to 1:50. This means that anyone who wants to provide liquidity to this pool must deposit Ether and link tokens at a ratio of 1:50.
- Defi pools rely on arbitrage traders to keep asset prices at their current market value. Let’s give you an example, if the price of a link token in the market is $ 35 and the price in an Ether/link platform pool is $ 34.5, arbitrage traders will detect this price difference and add more Ether to the pool to have profit from this price difference. So, they can receive the links at a lower price than the market.
- When arbitrage traders add another token to the pool to collect a cheaper token, the token ratio changes. The liquidity pool also automatically raises the price of more tokens and decreases the price of smaller tokens to restore the balance of the tokens. So, Arbitrage traders have the financial motivation to maintain the balance of the pool.
- When the pool balance restores, the increase in the value of the liquidity pool is often less, compared to when the same assets were held on the lending platform. This is called “unstable loss.”
Under these protocols, liquidity providers get some transaction fees in exchange for adding assets to the pool, which can retrieve unstable losses. UniSwap, for example, receives a 0.3% commission on transactions that are distributed among liquidity providers.
Unstable losses should not be a factor in scaring you away from the Defi space. It is much better if you look at it as a predictable and measurable risk that you should consider before lending assets.
Important Note: To reduce volatile losses, it is best to invest your liquidity in pools that hold less volatile assets (such as stable coins).
Flash Loan Attack
Flash loans are a type of unsecured lending without collateral just for Defi space. In the traditional centralized banking model, there are two types of loans:
Unsecured loans: In this type of loan, due to the lack of loan amount (for example, ordinary loans), there is no need to provide collateral.
Collateral loans: These loans have a higher amount and require collateral such as a deed of house, car, and investment. Throughout the lending process, banks use tools such as credit scores and account reporting to assess customer credit.
Quick loans are a type of unsecured loan that uses smart contracts to reduce the risks in a traditional centralized banking system.
A quick loan has a simple meaning, and that is: that the borrower can receive thousands of dollars of cryptocurrency without any collateral or bail. But the important thing is that in this type of loan, the funds have to be repaid in the same transaction that they were sent (usually within a few seconds).
If the loan is not repaid, the loaner can return the transaction. As if no such transaction had taken place and no one had received such a loan. Due to the zero risk of issuing this type of loan, there is no limit to the number of loans that a person can take. Also, since the whole process is decentralized, no one will ask you if you have a returned check or overdue installments.
Rapid lending attacks occur when a person uses these types of loans to borrow large amounts of money and use them to manipulate the market or exploit vulnerable Defi protocols to their advantage.
The instant loan attack that recently targeted PancakeBunny is one of the latest examples of such attacks. Shortly afterward, the profiteering aggregator platform made headlines in cryptocurrency news.
During this attack, the price of BUNNY fell by 95%. The attackers did this by borrowing a large amount of BNB from the Pancake Swap Lending Protocol, manipulating the price of BUNNY tokens in the lending pools, and then dumping BUNNY tokens in the open market, which eventually led to a fall in the price of this token. Just like the previous quick loan attacks, this time the thieves escaped without any problems.
When a particular token in a liquidity pool runs out of stock, liquidity suppliers may be exposed to volatile losses. It is clear that when lesser-known tokens (such as sponsors) are targeted, investors lose confidence in the projects. Also, the price of these tokens is rarely revived and returns to the previous price.
When a particular token in a liquidity pool runs out of stock, liquidity suppliers may be exposed to volatile losses. It is clear that when lesser-known tokens (such as the BUNNY token) are targeted, investors lose confidence in the projects. Also, the price of these tokens is rarely revived and returns to the previous price.
Best cryptocurrency lending and borrowing loans in Defi
Maker: Maker is a unique cryptocurrency lending platform in Defi that uses only Dai tokens for borrowing. Dai is a stable coin tied to the US dollar. Users can open an inbox using the Maker protocol and receive Dai tokens in exchange for locking collateral in the form of an Ether or BAT. This encourages participation in revenue-generating activities through government fees, which play the role of a profit rate for the network. It is possible to borrow a mortgage of 66% of the value of the collateral. If the price of the collateral falls below this fixed-rate, you will be subject to a 133% fine and liquidation. Liquidated collateral is then sold on the open market at a 3% discount.
Aave: This platform is an unsafe liquidity protocol for making a profit by depositing and borrowing cryptocurrencies. Aave allows lenders to receive the equivalent of an aToken by depositing their cryptocurrency into a pool. This platform algorithmically adjusts the interest rate depending on the supply and demand. This indicates that the more profitable aToken currencies are maintained by users, the greater the profitability.
Compound: Compound is an autonomous protocol and algorithm that aims to provide global free financial programs. This platform allows users to earn money and borrow other cryptocurrencies by depositing their cryptocurrencies. The use of smart contracts has automated the management and capital saving process on this platform. Web 3 wallets, such as MetaMask, have also enabled compounding and profiting.
Rug Pull Defi
First of all, the term “Rug Pull” refers to the theft of users’ funds by project developers and their escape with these funds. Rug Pull is ”money laundering” and in many cases, the persons behind it won’t get caught.
In the absence of all kinds of traditional rules in the Defi system, users are forced to trust the platforms which bring cash or buy tokens, and unfortunately, Rug Money scams might sometimes damage this trust.
Rug money is a scam, or more precisely, an “Exit Scam” in which Defi developers create a new token, create a trading pair with a major currency such as Tether, and open a pool of cash from that pair.
The project manager then starts marketing new tokens and encourages people to deposit in the pool by promising high profits. When a significant amount of the currency enters the pool, Defi developers use the escape routes already embedded in their smart contracts and run away with people’s money. These exit routes are codes deliberately placed in smart contracts and used to multiply millions of new tokens and sell them in exchange for popular currency. These exit routes are called “Back Door” or “Door”.
As a result, the price of sushi tokens fell to near zero; This event has been called one of the “most dramatic moments in the field of Defi”.
Scamming is a billion-dollar industry in Defi, and despite the efforts of developers to reduce the risks in this field, this scamming is still so common. In the second half of 2020, Rug Pull and Defi Exit scams established 99% of all Blockchain-based scams.
How to stay away from these 3 big threats in Defi platforms?
Despite the rapid growth of this type of sabotage activity, there are ways to check for risk in a company before investing, and here are some examples:
- Check team credibility in other projects
- Careful study of project white paper
- Check if the project coding has been checked by people other than the project team members
- Sensitivity to existing warnings (such as promises of unrealistic returns or excessive costs for advertising and marketing).
- Ultimately, the very designs eliminated the need for Defi protocols for intermediaries and give them the ability to revolutionize the financial industry and also make them vulnerable to theft.
Limited regulatory rules, along with the open-source nature of the Blockchain, mean that there are vulnerabilities in lending protocols that hold large amounts of money; But like the rest of the Blockchain industry, we expect that the risks of Defi projects get minimized over time.
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