DeFi Risk Classification

With the rapid increase of TVL, attacks on DeFi protocols have gradually emerged. In DeFi exploits, attackers gain profits from the vulnerability in the technical or economic security of the DeFi protocols Table VI summarizes DeFi risks and their impact on DeFi stakeholders - service customers, liquidity providers (LPs), arbitrageurs, or governance users. This section discusses these risks and attacks in detail. As yield farming protocols are aggregators that provide liquidity to other DeFi protocols, this category possesses risks of LPs.

DeFi risk classification is essential for navigating the complex landscape of decentralized finance. It involves categorizing various risks associated with DeFi platforms, including smart contract vulnerabilities, liquidity challenges, market volatility, operational disruptions, and regulatory uncertainties. Understanding these risk categories helps users and developers manage potential threats and ensure the security and stability of DeFi systems, fostering a more resilient and reliable financial ecosystem.

The blockchain trilemma states that every BC can prioritize only two from three factors: decentralization, security, and scalability. The limited scalability of the BC results in network congestion and high transaction fees. A lack of decentralization allows for transaction censorship. The security attacks target vulnerabilities in the technical (e.g., smart contract, transaction re-ordering) or economical design (e.g., oracle price manipulation) of DeFi protocols and BCs.

• Limited Scalability Scalability is the central issue for BC networks. The limited scalability leads to network congestion and spikes in transaction costs. During the network congestion, transactions of arbitrageurs, and other DeFi stakeholders, may not be executed, leading to market inefficiency and information delays. Layer-2 solutions aim to scale the underlying main chain at the cost of various security assumptions.

• Centralization Risk Centralization might affect both the BCs and the DeFi protocols. DeFi Protocols increasingly rely on governance tokens to decentralize the decision-making process. Nonetheless, the distribution of gov- ernance tokens may remain concentrated within the small groups of colluding stakeholders, as the distribution of voting powers is a gradual process.

• Security Threats DeFi Protocols operate on BC as smart contracts and are prone to security attacks on various layers: BC infrastructure, smart contracts, and application attacks.