How to Protect Yourself from DeFi Exploits and Loopholes

DeFi has become one of the most prominent uses of blockchain and sees virtually every financial service you can imagine delivered in a decentralized manner. This has meant greater access to financial services like insurance and loans, token swapping while preserving privacy, and much more.

But while DeFi has been successful, with billions of dollars locked on various protocols to prove it, it hasn't all been smooth sailing. There have been a few examples of various protocols being attacked by malicious actors and loopholes being exploited for nefarious reasons. As someone who uses DeFi, you'll want to be aware of these and protect yourself from them.

How DeFi Exploits, Hacks, and Loopholes Work

Before you understand how to protect yourself from these issues, it is worth understanding how they work in the first place. DeFi platforms, by and large, are governed by smart contracts. These smart contracts complete transactions automatically based on various preset requirements. For example, a DeFi-backed insurance platform might pay out if certain actions occur. Once it has been confirmed independently by the smart contract that the incident did occur, e.g., a natural disaster, the money is automatically paid out. The point of smart contracts is to make sure that transactions are completed with ease and are not dependent on human error.

How to Protect Yourself from DeFi Exploits and Loopholes

However, these protocols can be exploited in some cases. An example is back in 2021 when Yuag Labs, the parent company of the Bored Ape Yacht project, allowed token holders to mint its native currency ApeCoin. The setup was that anyone who held one of the Bored Ape NFTs could mint a certain number of coins for free. One person took out 8 ape NFTs on a loan and used them to mint a large amount of ApeCoin before returning them. In the end, they made about $1.1 million in profit. In this case, an unforeseen loophole that could be exploited was overlooked. Then, there are simply brute force attacks on DeFi platforms that could see funds drained. Millions of dollars have been lost to this so far, and the nature of cryptocurrency means that it is much harder to recover.

How to Protect Yourself

Now that you are aware of how DeFi exploits can occur, it is worth looking at different ways to protect yourself:

Use a Secure Wallet

One of the golden rules of protecting yourself in the crypto space is having the best possible wallet. A wallet that is optimized to resist hacking attempts and keep user data and funds safe is a must. Keep in mind that many DeFi platforms don't require you to create a membership but instead, ask you to connect your wallet to complete transactions. By having a secure wallet, your funds are less vulnerable when connected to various platforms. Look for the best DeFi wallet on the market and make sure to keep your sensitive details like your password and recovery phrase safe from prying eyes.

Separate Your Funds

Because DeFi platforms require connecting wallets, thus creating a level of vulnerability, it is best to separate your funds. Say you have five Ether tokens in your wallet and want to swap one for a different crypto using a DeFi protocol. Rather than having the entire five tokens in your wallet when you connect it, consider moving the four tokens you aren't using to a hardware Wallet. A hardware wallet is not connected to the internet at all and thus, cannot easily be stolen from. By connecting a wallet with only one token in it, you minimize the amount of exposure you create. This way, if the worst happens, your funds will still be safe.

Understand Vulnerabilities Before Signing Up

Also, as in our previous example, a lot of exploits have to do with smart contract rules that can be maliciously applied. Oftentimes, this only becomes apparent after the fact, and so, you need to get ahead of the matter. Before you sign up on any platform, look at its smart contract setup and try to find any possible vulnerabilities. Think back to the Yuga Labs example. While the rules plainly meant that anyone holding an NFT from the collection could get free tokens, it never specified from which date they must have been holding the token or that they couldn't use a loaned token to acquire the funds. In this case, it was a genuine error that was overlooked. But that is not always the case.

It is not unheard of for DeFi protocols to deliberately have such things in place to later exploit users. This is more common with newer and unverified Projects, so beware of them. An idea would be to find the smart contract policy for the platform and have an AI look over it and highlight any possible vulnerabilities. This will let you know what risks might be associated with the platform and thus, what you should look out for.

Be Wary of Airdrops

The DeFi space is chock-full of free airdrop opportunities that promise to give you tokens, NFTs, and other assets for whatever reason. While they are legitimate airdrop opportunities, there are also lots of scams. The first thing you should do is avoid clicking any dodgy link you don't have context for. If you see a link on Twitter promising free tokens for no reason, don't immediately click on it, but instead, do some research regarding whether or not it is legit. If you do decide to click on such a link, make sure all of your existing tokens are moved to a hardware wallet. That way, if it ends up being a scammy link, there will be no funds for the nefarious actors to steal. While airdrops can be rewarding, they can also be a gateway to exploitation, so be careful.

Research Platforms and Assets

Another crucial step to take to protect yourself would be to research various platforms before you go ahead to use them. Say a new decentralized exchange pops up on the market. Before you start using it, read user reviews, check its name on forums, and make sure that it is a legitimate one. You should also check to see if it has suffered any hacks in the past and, if so, what steps it has taken to address any of its vulnerabilities.

Before you swap any tokens on a DeFi protocol, check it through platforms like CoinMarketCap and CoinGecko to make sure it is legitimate. Doing these means that you're less likely to fall victim to a scam and can operate with ease.

Conclusion

Decentralized finance is one of the most innovative offerings of blockchain technology and opens up a whole new world of opportunity for users. But even with this, it is not free of its pitfalls, and one of the most common is protocol exploitation and targeted attacks. While you cannot stop nefarious actors from targeting both you and the protocols you use. But you can take the steps that we've highlighted and apply them every time you engage with a DFi protocol. By doing this, you're less likely to use flawed protocols, fall victim to scams, or get the short end of the stick when it comes to DeFi.