DeFi Red Flags and Risks Explained | dApps Fight for Survival Q1 2022

4 min read


As a result of high leverage, liquidity mismatches, a lack of shock-absorbing capacity, and built-in interconnectedness, decentralised finance (DeFi) has a lot of vulnerabilities.

“DeFi is a rapidly-growing part of the crypto market that promises traditional financial products without involvement from middlemen such as banks. Regulators are increasingly concerned about platforms offering DeFi services that may not be as “decentralized” as advertised.” – Ryan Browne, CNBC


DeFi world

Image Credit: BeInCrypto

It’s no longer enough for DeFi initiatives to simply hand out tokens to attract investors. As DeFi is not just a fringe of financial interactions, the standards for projects in the space are rising. 

The recent market downturn is a reason for concern in the crypto space. At the time of writing the mighty Bitcoin (BTC) waivers between $36,000 – $37,000. Despite this being a high-low in terms of Bitcoin’s history, many are feeling the effects of this plummet.

As with a typical Bitcoin-induced market turndown, the entire crypto industry feels the burn: from alt-coins to DeFi. Impressive all-time-highs aren’t on the horizon and many are HODLing on for life. Therefore initiatives need more innovation to remain afloat. Projects throughout the crypto space will need to continue to push innovation in order to ensure the ecosystem remains robust despite the drop.

DeFi dApps in the drop

According to a recent comment from a DappRadar executive, if the bear market continues, a large portion of the decentralized applications will disappear. His estimates figure only around 20% of the dApps which hold 80% of the industry value will survive.

On one hand, a dApp washout like this could perhaps weed out unsustainable projects in the various DeFi ecosystems. However it could also reduce the playing field for those looking to pave their own way in the space. Massive amounts of DeFi projects are either a hindrance or welcome-mat to the market. An overwhelming amount of options at such a new stage may seem unfruitful. Or, it is a welcoming sight due to the expanse of possibilities?

Last month a report from Electric Capital declared that $100B worth of locked value in the decentralized financial space comes from less than 1,000 developers. These numbers reveal the stark possibilities of the Dapp Radar executive’s estimate. It also suggests that smaller projects in the space with the will to survive must become innovative with token-incentive and use-case practicality.

Bear market, regulations, security – oh my! 

Other challenges presented to the DeFi community in the midst of this market downturn, come in the form of regulations and security. While some DeFi projects vie for their existence, regulations from major federal entities may make this struggle more difficult.

In the United States, deliberations from the Securities and Exchange Commission (SEC) over crypto regulations are still ongoing. Moreover the question of how and when to regulate DeFi also remains. A recent proposal on January 26th, could give regulators overarching power over crypto exchange. This is a move in exact opposition to the core of decentralized finance.

Commissioner Hester Peirce recently said the 654-page plan could particularly threaten decentralized finance trading platforms. Though the document didn’t explicitly mention crypto or DeFi, the aim to close the “regulatory gap” certainly targets these booming industries.

Not to mention the serious hacks over the last year. In 2021, a major year for DeFi development, 44 big hacks came from centralized issues. In other words, a lack of proper decentralization.

Yesterday the Solana DeFi project, Wormhole, was hit with a hack, with potentially $320 million lost. Wormhole is important to the ecosystem as it serves as a link between Solana and other DeFi networks.

Circumventing the bear market

The messy combination of a bear market, impending regulations, and regular hacks have contributed to the tumble of DeFi tokens. Despite that, DeFi adoption continues increasing, according to Consensys data.

For all these investors and developers entering DeFi, and for projects to circumvent the current conditions, things must change. Standards must rise. It’s no longer enough for DeFi initiatives to simply hand out tokens to attract investors and dust off their hands as if the work is done. The stakes of loss and disruption are higher.

A key way to do this is through meaningful, even incentivized participation, is to make sure DeFi projects grow and scale. At the moment, token airdrops are a common form of distribution. Though, they don’t often procure the results the protocols desire. Often people end up dumping their tokens – which also is not good in a bear market.

An example of a project doing such work is Step Finance, the front page of Solana. The protocol plans to launch a new kind of incentive mechanism for users on the network – Rewards Options. Although this initially sounds like a token airdrop scheme, look closer – it’s not.

The Options reward 12,000 users already active on the automated market maker (AMM). Rather than the main bid of the airdrop being to attract a community, which loses momentum with time, as seen with GasDAO and OpenDAO, these airdrops go straight to the already existing community. This in turn feeds the community.

George Haarp, the co-founder of the STEP Finance project says something like this sets the agenda for the future of DeFi – moving away from the airdrop models and into this productive reward model. “The logic and mechanism for this tool are applicable to all chains and projects in the space.”


Summary: A Decentralized Future

A shift towards incentive-based tokenomics is happening slowly and quietly across the DeFi space. It also needs other improvements, in order to create a meaningful space and continue an expansion from the fringes of crypto communities to mainstream operability.

Another example similar to the Step Finance one mentioned above is Andre Cronje’s similar incentive mechanism for his new AMM model. Already this has been done in the crypto space outside of strictly DeFi projects like with Cardano’s Project Catalyst, which gives developers and creators ADA to develop on Cardano. Recently the Project has funded a lot of DeFi projects.

However, all this indicates that the status quo is shifting, with more expected tokens in DeFi. Token utility and accessibility are setting the standards higher, but they’re not the only thing. Also, oracle development, strengthening DeFi security, and further decentralization are a part of the winning combination for a DeFi sector that can not only survive a bear market, but thrive in one.

Via this site: The Rising Standards of DeFi Amidst A Bear Market

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