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The defi space has been relatively tranquil in recent times. At the beginning of 2023, the stablecoin trading project Platypus encountered a flash loan attack on AAVE, resulting in a loss of $9 million worth of assets. Since then, things have seemed to calm down in the defi space.
Unfortunately, the lack of any earthshaking security breaches in the past few months should not be misinterpreted as a sign of great improvement in terms of safety. I think the defi space remains highly vulnerable to critical security lapses that could spell disaster for protocols.
It is essential to be aware of these overlooked but significant risk factors that can cause major pitfalls in the protocol if not appropriately addressed. Let’s examine some of the main underlying causes of potential security breaches.
Key mistakes in attitude that protocols should watch out for
Security breaches are still very common in defi protocols, even if they don’t always make the headlines. A lot of the time, these breaches are a result of common mistakes made by the concerned people unknowingly. There are two major examples of such mistakes that can lead to security vulnerabilities.
The first is not monitoring the reports about potential exploits or vulnerabilities in forked defi protocols, which can have severe consequences for the project and its users. Suppose the issues within a newly made fork are not identified and addressed. In that case, malicious actors may take advantage of it to compromise the protocol’s security, leading to financial losses and high-level system manipulation.
Moreover, forked defi protocols are often interconnected with other projects in the ecosystem, which increases the significance of the potential issues to a greater extent. Forking is encouraged, but it can turn out to be a massive problem if the developers do not integrate security updates properly.
The second big mistake stems from the fact that defi projects are often under immense pressure to be launched quickly in the market. In the spirit of this field’s frenetic pace, developers often tend to compromise on planning quality and extensive security tests. As a result, the protocols developed are susceptible to a wide range of security threats, such as zero-day vulnerabilities.
A zero-day vulnerability can occur when the underlying software has a flaw that has not yet been discovered by the vendor. In such a case, an attacker can easily manipulate the system and take full advantage of the vulnerabilities present in it even before any defense mechanisms can be implemented.
The missing link: Specialized expertise in defi development
Despite the various concerns the TradFi sector faces, it does enjoy one pivotal advantage, specifically, the presence of a large pool of experienced and skilled professionals who are well-versed in this industry’s nuances. By comparison, the absence of such specialized expertise in defi is one of the most significant issues that exacerbate the security concerns for this space.
I’ve observed on multiple occasions that defi protocols tend to lack the guidance of product owners who are well-versed in both the intricacies of the crypto market and the nuances of finance and economics.
Most project teams tend to fall into one of two camps. The first comprises people who came from the TradFi scene and are struggling to adjust to the pace of the defi market and apply it to their development practices. This can, at times, result in one of two undesirable outcomes. Either the development is rushed, and the end product gets released half-baked and full of potential vulnerabilities, or it takes too long, and the product misses the opportunity to claim its portion of the market.
Conversely, we have people who have only ever operated exclusively in the crypto market. Because of this, they fail to understand the importance of various elements that could be covered with TradFi’s background and knowledge base. This often leads to inadequate security practices when it comes to things other than smart contract audits and code quality. Vulnerabilities that have to do with market and economic risks are left unaccounted for.
The defi space depends on a well-structured tokenomics model; to create that, the developers would need a thorough understanding of economics. Inexperienced developers may create ineffective token systems, leading to issues such as inflation, deflation, or an imbalance in user economic incentives.
In light of this, the defi sector requires a balanced group of specialists who need to know how to select reliable oracles, understand the liquidity management challenges, deal with interoperability with other blockchain platforms, and be cognizant of building intuitive and user-friendly interfaces to attract and retain users.
Preparing for the future: Security amidst centralization concerns
It is an undeniable fact that the defi landscape has been evolving rapidly, and there are considerable prospects for the entire ecosystem. However, the pressing security concerns cannot be ignored, especially when there are many instances of large-scale financial losses.
Ever since the inception of defi, there have been concerns about the whole ecosystem becoming an indirect counterpart to TradFi. Even though decentralization is an attractive concept, achieving it has had its own share of challenges. To avoid falling down the same security pitfalls defi protocols have recently begun introducing various caps and limits on certain activities that users can perform.
It might be seen as restrictive and an act of strengthening centralized control, but these measures make quite a bit of sense when there are grave security concerns to deal with. As the industry matures, these measures become essential to instill confidence among the newcomers to this sector, who often include conservative investors and traders from the TradFi scene.
In my opinion, having robust security practices sets the foundation for a well-structured defi ecosystem that can enjoy the trust of its users. Frequent protocol launches and increasing market concentration would not be effective unless the security aspects are taken care of. The industry needs to concentrate on building a reliable system and concentrate on the various security threats that have been wreaking havoc in the development of this space.
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