What are the Risks Involved in DeFi Mining?

October 31, 2022

For many, lucrative DeFi protocols will always flame up the fear of missing out almost instantly. However, the APY cannot be sky-high forever: with more users rushing in, all the craze will eventually calm down. On the other hand, high returns are often, if not always, accompanied by high risks such as rug-pulls, impermanent losses, and contract loopholes. Today’s TRON 101 will explain some of the risks associated with DeFi mining.

Rug-Pulls 

A well-known jargon in the crypto world, a rug-pull is a fraud scheme where the project team tricks people into a cryptocurrency project and then suddenly abandons the project, a particularly common fraud among DeFi projects. Sometimes the developers may withdraw unexpectedly from a DEX liquidity pool, taking away all the funds. 

Rug-pull metaphorically means innocent investors standing on a rug while the development team pulls the rug without any warning: the stumbling investors suffer heavy losses. 

Rug-pulls usually happen in new projects where fraudulent developers inject new tokens and some stablecoins into a liquidity pool and pump up the price of the new token by marketing. As more users convert their cryptocurrencies into the new token, the team sells off all their own supply, driving the token price down to zero and making a huge profit. 

One reason for rug-pulls’ high incidence in DeFi is that creating new tokens on a blockchain is very inexpensive. Also, since there is no auditing mechanism in DEXs as in CEXs, many unaudited tokens have mushroomed in the market. Therefore, you have to DYOR (Do Your Own Research) on the team, history, and use case behind a project before making any investment decisions. 

Impermanent Losses

Many DeFi players must have had such an experience: they provide liquidity to a certain pool and expect returns but only end up losing their money. This is the so-called impermanent loss.

The term “impermanent loss” is misleading because it suggests that such loss is not permanent. As it is caused by market volatility, impermanent loss occurs regardless of a price upturn or downturn and is only eliminated when the price moves back to the initial level. But since such a scenario is very rare in the real world, impermanent loss often becomes a permanent one. 

Due to the price volatility of cryptocurrencies, impermanent losses are virtually inevitable. Therefore, users should set their sight more on liquidity pools with major or low-volatile tokens and choose those with stablecoin trading pairs, which often incur minimal impermanent losses, or even zero. For example, SUN.io’s smart mining pool USDD-USDT LP (flexible and fixed terms) offers an APY of up to 39.66%. Of course, you can also choose mining in a single-currency pool to avert impermanent losses. 

Loopholes in Smart Contracts

Sometimes hackers may take complete control over a DeFi mining project by exploiting loopholes in a contract, looting all assets in the liquidity pool. To avoid such risks, it is necessary to pick a project with a creditable team and ensure the smart contracts have been fully audited. But even so, such risks cannot be fully eliminated.

Data from Beosin and Footprint Analytics show that there were 33 attacks on DeFi contract loopholes in the first half of 2022, with Solana ranking first, suffering losses totaling $374 million. Ethereum and BNB lost $93.58 million and $90.93 million, respectively. So, it is vital to choose a safe and reliable trading platform, such as TRON.