What are the risks of using DeFi Protocols?

What are the risks of using DeFi Protocols?

DeFi protocols are innovative and outfitted with incredible functionalities. People lend, borrow, stake, farm, and do other decentralized financial activities on these protocols daily. The opportunities available to their users are numerous, but their risks still exist. 

A crypto enthusiast may have noticed issues in the DeFi space, like hacks and attacks. Lately, DeFi protocols have become a target for hackers. Hence, before using a decentralized finance protocol, it is vital to consider the potential risks. 

  • Blockchain risk

DeFi protocols are based on blockchains, meaning if an issue affects the blockchain, it could affect the functioning of the whole platform. If a blockchain breaks down or becomes congested, it could negatively affect the platforms' operations built on it. For instance, carrying out transactions on the congested Ethereum network is expensive. Users have to worry about paying high gas fees before utilizing an Ethereum-based DeFi protocol. 

  • Internal risk 

Generally, a DeFi protocol may need a smart contract to function effectively. However, there are risks attached to the internal architecture of these protocols. For instance, there is the probability that a bug may make the protocol's architecture act poorly. The slippage may be too high, making the users pay high fees. In addition, intrinsic attributes of a protocol can affect its operations negatively, thereby making it a Herculean task for users to utilize. 

  • Governance risk 

Though DeFi protocols use a decentralized governance system, they can still be centralized in nature. Usually, those with the highest number of tokens can determine what happens in the platform, like the collateralization ratios. 

  • External risk

Hackers are always on the prowl for vulnerability in a DeFi protocol. For example, they could exploit a bug in the codes and drain the pool. Common examples of these attacks are the hot wallet attack and flash loan hack.

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