Welcome to our latest blog post on the exciting and ever-evolving world of DeFi! In this post, we’ll be diving into the nitty-gritty of the most common causes of lost funds in DeFi and exploring ways in which they can be prevented and potentially insured against. From smart contract bugs to phishing scams, we’ll cover it all!
So grab a cup of coffee, sit back, and let’s dive into the world of DeFi insurance together!
The most common causes of lost funds in DeFi include:
- Phishing scams: These involve tricking users into sending their funds to a fake version of a legitimate site or contract.
- Exit scams: This occurs when a project or protocol founder runs away with the funds.
- Rug pulls: This is when a project or protocol founder suddenly and unexpectedly withdraws liquidity from a market, causing the value of that market to crash.
- Human error and lack of proper due diligence: Failure to thoroughly research and understand a project or protocol before investing can lead to the loss of funds.
- Smart contract bugs and hacks: These can lead to unintended consequences, such as the freezing or loss of funds.
Let’s dig into each in more detail.
Phishing scams
Phishing scams are a type of fraud where a malicious actor tricks users into sending their funds to a fake version of a legitimate site or contract.
This can be done by creating a fake website that looks similar to the real one, or by sending out emails or messages that contain a link to a fake site. Once the user enters their private key or seed phrase into the fake site, the attacker can then use that information to steal the user’s funds.
Phishing scams can be particularly dangerous in the DeFi space, as many of these projects and protocols involve the use of complex smart contracts, which can make it difficult for users to distinguish between a real and fake site.
Currently, there is no specific type of insurance that covers phishing scams in DeFi, but some solutions have been proposed to help prevent these types of attacks.
One solution is to use decentralized identity solutions like ERC-725/735, which allow users to prove their identity on the blockchain without having to share their private key or seed phrase. This would make it more difficult for attackers to steal a user’s identity.
Another solution that’s been proposed is the use of blockchain-based browser extensions like MetaMask, which can help users to verify that they are on a legitimate site before entering their private key or seed phrase. This can be done by looking at the site’s smart contract address and comparing it to the address of the legitimate site.
InsurAce and other similar companies are also exploring ways to offer coverage for phishing scams, by creating a pool of funds that can be used to compensate users in the event that they fall victim to a phishing attack.
This type of coverage would require a significant amount of collaboration among different companies, projects, and protocols as well as regulatory bodies to be put in place.
It’s important to note that while these solutions may help to reduce the risk of phishing scams, they cannot completely eliminate the risk.
Therefore, it’s crucial to be vigilant and to take steps to protect yourself, such as by verifying that you are on a legitimate site before entering your private key or seed phrase.
Exit scams
Exit scams are a type of fraud where a project or protocol founder runs away with the funds.
They typically involve creating a fake or fraudulent project or protocol, and then convincing investors to put their money into it.
Once the founder has collected enough funds, they disappear, leaving investors with no way to recover their money.
Exit scams can be particularly devastating for investors in DeFi, as the decentralized nature of these projects and protocols means that there is often no central authority that can be held accountable for the loss of funds.
Currently, there is not a specific type of insurance that covers exit scams in DeFi, but there are some possible solutions that have been proposed.
One idea is to have a multi-sig system in place for large fund withdrawals, where multiple parties must sign off on a withdrawal before it can be executed. This would make it more difficult for a single person to run off with the funds.
Another idea is to have a system of reputation or reputation-based access controls in place, where investors can check the reputation of a project or protocol before investing. This would make it more difficult for scammers to launch new projects or protocols.
Due diligence and research before investing is still the best way to protect yourself from this type of fraud.
Exit scams in DeFi can be devastating for investors as they involve a project or protocol founder running away with the funds.
There is currently no specific type of insurance that covers exit scams in DeFi, but that doesn’t mean it’s not possible in the future!
Rug Pulls
A rug pull refers to a situation where a project or protocol founder or a group of individuals behind a project or protocol, suddenly and unexpectedly withdraws or “pulls” liquidity from a decentralized finance (DeFi) protocol, resulting in a sharp decline in the value of the tokens and causing significant losses to the investors.
This occurs when the project or protocol’s liquidity is held in a smart contract, and the creator of that smart contract suddenly moves it to a different address, effectively taking the funds.
Preventing rug pulls is a difficult task, as it requires identifying and monitoring all the different projects and protocols that are operating on the blockchain. However, some solutions have been proposed to help reduce the risk of rug pulls.
One solution is to use liquidity pools that are governed by a decentralized autonomous organization (DAO) rather than a single entity.
This can help to ensure that the funds in the pool are more secure, as the decisions about how to manage the funds are made by a group of individuals rather than a single person.
Another solution is to use smart contract audits, which can help to identify potential vulnerabilities in a smart contract before funds are invested.
This can help to identify potential issues with a project or protocol before funds are invested, and can help to reduce the risk of rug pulls.
InsurAce and other similar companies are also exploring ways to offer coverage for rug pulls, by creating a pool of funds that can be used to compensate investors in the event that a rug pull is discovered.
This type of coverage is called “Rug Pull Protection” coverage, which may have a higher premium rate as it is considered a high-risk coverage. It could also be backed 50% by the protocol themselves to show a sign of trust that they will not do a Rug Pull on their users.
Human Error
Human error and lack of due diligence refer to situations where investors lose funds due to mistakes or oversights on their part, rather than as a result of a malicious attack or scam.
This can include things like sending funds to the wrong address, mismanaging private keys or seed phrases, or failing to properly understand the risks associated with a particular investment.
Preventing human error and lack of due diligence can be challenging, as it requires individuals to take personal responsibility for their own financial decisions. However, some solutions have been proposed to help reduce the risk of these types of losses.
One solution is to provide better education and resources for investors, such as guides and tutorials on how to safely invest in DeFi projects and protocols.
This can help to ensure that individuals have a better understanding of the risks and potential rewards associated with different investments.
Another solution is to use smart contract wallets and other types of software that can help to automate the process of investing and managing funds, and which can help to reduce the risk of human error.
The type of coverage required for this issue is similar to “Investment Loss” coverage in traditional financial markets, also to Errors and Omissions coverage.
The problem is that it is an extremely subjective type of coverage and the evidence of this would be difficult to prove its validity.
Smart Contract Bugs & Hacks
Smart contract bugs can be a major concern in the DeFi space, as they can lead to unintended consequences, such as the freezing or loss of funds.
However, there are ways to protect yourself from these types of issues. One such way is through smart contract insurance.
We at InsurAce provide coverage for a variety of risks associated with smart contracts, including bugs, vulnerabilities, and other issues.
This type of coverage can help to protect users from financial losses in the event that a smart contract bug is discovered.
According to a study by InsurAce, over 30% of all smart contract vulnerabilities are caused by bugs, making it the most common type of issue. Additionally, the study found that the average cost of a smart contract bug is over $1 million.
By purchasing smart contract insurance, users can feel more secure in their investments, knowing that they are protected in the event that a bug is discovered.
It is important to note that purchasing smart contract insurance is not a substitute for proper due diligence and research, but it can provide an added layer of protection for your investments in DeFi.
Smart contract hacks can also be a major concern in the DeFi space. These types of attacks involve exploiting vulnerabilities in a smart contract to steal or divert funds.
However, just like smart contract bugs, there are ways to protect yourself from these types of issues. One such way is through smart contract insurance.
Smart contract insurance can also help protect users from the financial losses that can occur due to smart contract hacks.
Check out what we can help: app.InsurAce.io
About InsurAce
InsurAce is a leading decentralised insurance protocol, providing reliable, robust and secure insurance services to DeFi users, allowing them to secure their investment funds against various risks. Being the 1st in the industry to offer cross-chain portfolio-based covers, InsurAce enables users to get unbeatable low premiums. InsurAce has been live since April 2021 and has built a full-spectrum cross-chain insurance product line, covering Smart Contract Vulnerabilities, Stablecoin De-Peg events, IDO risks, and Custodian Risks… protecting over $350m of assets of 5000+ customers!
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