Navigating Risk

Phishing attempts & Private Keys

Your private keys¹ and seed phrase² are the keys to your wallet and anybody who has these keys can get in, these are for your eyes and your eyes only. No customer support will ever ask you for your private key or seed phrase. Be aware of social engineering and phishing attempts to obtain your private information or download malware into your devices, avoid clicking links from unreliable sources and never download files from strangers. Only use reputable exchanges and products to mitigate risk of scams and trojan attack vectors. 

Learn more: Common Scams on Mobile Devices, Binance Academy

Smart Contract Exploit

Smart contract exploits happen when a bad actor takes advantage of an existing code for their own benefit. In DeFi, it's important to understand how exploits happen and know how to defensively protect yourself from the impact of potential exploit. The strongest ways to mitigate smart contract risk are only using reliable protocols, using a hardware wallet, and revoking approvals. 

Learn more: What is Smart Contract Risk?, Coinmarketcap Alexandria

Volatility

Be aware of potential volatility when buying tokens on DEXs, providing liquidity and staking in protocols. Price volatility is directly related to impermanent loss incurred in liquidity pools. Use single sided asset pairings and highly correlated pairs to avoid impermanent loss, avoid staking with high volatility tokens.

Black Swan Events

A black swan refers to an unpredictable, low probability event that results in catastrophic consequences, the term was popularized by Nassim Taleb in The Black Swan: The Impact of the Highly Improbable. Taleb's interpretation of black swan theory as it applies to any event contains three components: Rarity, Results in Severe Consequences, Rationalized Post-Occurrence. 

Learn more: Black Swan Theory, Wallstreet Prep

An example of a recent black swan event in the crypto industry is the depegging³ of UST and collapse of Terra Luna, resulting in a $60 billion dollar wipeout on the market. Black swan events are often not isolated to the event that causes them, but continue to create ripple effects in aftermath. In the months following the collapse of UST and Terra Luna, we saw the subsequent collapse of CeFi⁴ lending platforms Voyager and Celsius, as well as the fall of Su Zhu & Kyle Davies' Three Arrows Capital. It is important to keep in mind that contagion⁵ often follows black swan events in crypto. Popularized methods of mitigating risk for black swan events include portfolio, protocol and wallet diversification, don't put all your eggs in one basket.

Learn more: Unstable Stablecoin: How Cryptos Crash Broke the Buck for Terra's UST, Forbes - Crypto Broker Voyager Digital Files For Chapter 11 Bankruptcy, Forbes - Bankrupt Crypto Lender Celsius Receives US Grand Jury Subpoena, Bloomberg - 3AC Founders Su Zhu & Kyle Davies Have Vanished, Like Terra LUNA CEO, Be in Crypto

Regulation & Censorship

DeFi is a new branch of blockchain technology, as such it is subject to heavy scrutiny by regulators and subsequently, centralized entities. When interacting with DeFi it is important to be aware of potential regulatory changes and ways they may affect you. 

A recent example of sanctions and regulations on DeFi, directly impacting users, is the Tornado Cash sanctions by the Treasury Department and OFAC. Tornado Cash is a well known privacy mixer, used to facilitate private transactions; the primary purpose of Tornado cash is to obscure the sender from the recipient, breaking the trail from the origins of the assets. 

Learn more: What are Coin Mixers and How do They Work?, Decrypt

In 2022 the Treasury Department and OFAC issued sanctions on Tornado Cash and all wallets that had interacted with the protocol, resulting in several DeFi front ends⁶ (subsequently attempting to remain compliant) blacklisting wallets that had interacted with the Tornado Cash protocol. 

It is however important to note that while a front end can blacklist a user from an interface they can not blacklist a user from a decentralized protocol. Meaning, if there is more than one front end, a wallet will still have access to the protocol. This is not true when dealing with centralized entities, such as USDC Circle, who have the ability to blacklist with finality. 

Learn more: Trust, Intermediaries and Censorship, The Defiant - Tornado Cash Sanctions By U.S. Treasury Draw Outrage, Suits From Community, Forbes