What Is DeFi?
Decentralized finance, also known as DeFi, uses cryptocurrency and blockchain technology to manage financial transactions.
Blockchain and cryptocurrency are the core technologies that enable decentralized finance.
When making a transaction in a conventional checking account, it’s recorded in a private ledger—banking transaction history—which is owned and managed by a large financial institution. Blockchain is a decentralized, distributed public ledger where financial transactions are recorded in computer code.
When say that blockchain is distributed, that means all parties using a DeFi application have an identical copy of the public ledger, which records each and every transaction in encrypted code. That secures the system by providing users with anonymity, plus verification of payments and a record of asset ownership that’s (nearly) impossible to alter by fraudulent activity.
When blockchain is decentralized, that means there is no middleman or gatekeeper managing the system. Transactions are verified and recorded by parties who use the same blockchain, through a process of solving complex math problems and adding new blocks of transactions to the chain.
As of mid-2020, DeFi has been experiencing profound levels of growth. The total value locked in DeFi protocols in August 2021 was almost $75 billion. With such massive amounts of money placed at stake throughout different DeFi protocols, it is important to identify decentralized finance security risks. The identification of security risks in the domain of DeFi could help in anticipating productive safeguards for the massive investments in DeFi protocols.
Here are some of the notable entries among DeFi security risks.
⦁ Wrong Liquidity Pool Estimates
The most general issue leading to security risks in DeFi is the incorrect calculation of the value of ⦁ tokens in the liquidity pool. DeFi users invest their tokens in a liquidity pool and receive a stake which helps them in obtaining value in the future. The unbalanced pool could result in incorrect calculation of token value while enabling attackers to compromise value in the pool.
⦁ Compromised Private Keys
Another formidable issue that emerges among security risks in DeFi would refer to stolen or leaked ⦁ private keys. Different DeFi projects, as well as users, have experienced losses of crypto by using malicious versions of MetaMask. The DeFi security risks due to stolen and leaked private keys also emerge due to poor practices for key generation. Another potential way in which you can lose private keys leading to common DeFi attacks refers to loss or theft of the seed phrase. The seed phrase or mnemonic phrases offer an easier way of remembering private keys.
⦁ Frontrunning Attacks
The time between creating a transaction and including it in the ledger is a gleaming opportunity for front-running attacks. Attackers would generally seek out the transactions which they could compromise by leveraging the Miner Extractable Value. many attackers or bots would leverage frontrunning for making profits according to their prior knowledge of transactions of a user. However, in some cases, the attackers would stage an attempted exploit followed by returning the compromised tokens to the exploited protocol.
⦁ Rug Pulls and Ponzi Schemes
Various DeFi protocol attacks emerge from external threats. Rug pulls are one of the most common examples of insider attacks in DeFi. It is one of the common DeFi attacks in which an individual in the company having access to the company’s contracts misuses their privileges for draining value from the protocol. In all cases, the project and the team disappear into oblivion with little left to solve the issue.
⦁ Inefficient Access Control
The privileged functions are specially tailored so that the owner of the smart contracts can call the functions. the access controls are implemented wrongly or not at all, thereby opening up doors for attackers. Hackers could gain privileged access to a smart contract, and they could exploit value by using the smart contract to their advantage.
⦁ 51% Attacks
51% of attack is more common in the case of ⦁ Proof-of-Work protocols and arises primarily due to the design of blockchain ⦁ consensus algorithms. attackers gain control over a major share of the computational power of a blockchain. As a result, they could easily ensure faster growth of their blockchain in comparison to legitimate blockchains. Subsequently, attackers could exploit the security risks in DeFi through the 51% attack and rewrite the contents of the distributed ledger. Most importantly, 51% of attacks could also open up possibilities for double-spend attacks. Therefore, 51% of attacks could easily threaten the security of DeFi protocols running on smart contracts.