Managing Risk in DeFi
Decentralized finance (DeFi) has been around for a while and we’ve seen it evolve into the complex system of interconnected protocols, DEXs and platforms that it is today. Still, there are various risks that participants are trying to address and minimize. Some of these risks were brought into DeFi from CeFi while others stem from the unique nature of decentralized protocols and the way they operate.
For a long time now, the global financial industry has been dominated by centralized systems. However, due to the economic crises that have occurred in the past few years, the inequities in the global financial system have created a challenge for innovators in the field. One promising solution is DeFi, which is a secure and transparent platform for financial transactions.
It is important to understand the various risks associated with the development and implementation of DeFi in order to maximize its efficiency. Having a deeper understanding of these risks can help you make informed decisions when it comes to the use of DeFi services. This discussion will help you identify the potential advantages of this technology.
Unlocking cross-chain interoperability and DeFi value
The emergence of DeFi and the transition from Proof-of-Work to Proof-of-Stake are some of the major events that have occurred in the blockchain space over the past few years. The next major event that will affect the industry is the interoperability between all the layer 1 blockchains. This will allow for the creation of a highly composable ecosystem of financial assets and allow users to extract more value from their assets.
To this effect, we have been hearing more about yield farming in the past year. Amid a continuing bear market, yield farming gained popularity as a way of transferring funds between different DeFi staking platforms in order to maximize profit. Essentially, this type of activity allows people to earn passive interest by making their assets available to lending or liquidity pools.
Staking in DeFi provides users with all the benefits of decentralized platforms. In other words, you can earn more money because:
- Typically DeFi platforms provide more liquidity
- You have more control of funds due to smart contracts
- Greater accessibility and anonymity
Staking platforms can act as crypto banks and provide both lending and borrowing services. They can earn from both the stakes and the crypto networks. This allows them to provide a high level of safety and liquidity.
What are the risks with DeFi staking?
With the benefits in mind, there are certain risks associated with DeFi staking that you need to be aware of, including:
- Market Risk: The market risk is the most significant factor that investors should consider when it comes to investing. For example, if you are earning 10% and the value of your coin drops 40% throughout the year, then you are at risk.
- Lockup Time: Some assets have lockup periods that prevent you from withdrawing your funds. This means that if the price of your assets drops, your returns could be affected.
- Illiquidity: If you are planning on staking a micro-cap coin, make sure that you have high liquidity. This will allow you to easily sell or convert it to stablecoins.
- Rewards distribution: Some coins do not pay out rewards daily. This means that instead of waiting for them to pay out, you have to wait longer to earn more. This could decrease the amount of time that you spend reinvesting your rewards to earn more.
- Slashing: Having the proper technical skills to run a successful node can help minimize the risk of issues with staking. One of the most important factors that you should consider is the availability of nodes. Since they are always active, they should be able to perform well and avoid penalties.
- Minimum holdings: Most projects require a minimum amount of money to be invested in order to receive rewards. This is why it’s important that you thoroughly check the terms of the agreement before staking any coin.
- Loss/hack — finally, there is always an ongoing risk of losing private keys or getting your PK hacked.
What’s needed for the future
Due to the lack of interoperability and inefficient capital deployment, liquid staking is considered an innovative solution that can help solve some of the issues that affect the development of DeFi. However, it needs to be improved in order to become more transparent. One of the most important factors that you should consider is the availability of blockchains, which can help minimize the risk of issues with staking.
With the increasing number of projects that are focused on using PoS technology, liquid staking is a valuable tool that can be used to improve the efficiency of various financial applications. It eliminates the need for people to unspool their assets in order to perform their transactions.
The development of a robust cross-chain interoperability framework that includes liquid staking derivatives and new stable assets could eventually become the gold standard for decentralized financial institutions. Through the use of liquid staking, financial institutions can perform their transactions more efficiently and improve the efficiency of their capital. It can also help promote decentralization and accessibility within the ecosystem.