DeFi Risk Categories
DeFi risk isn't monolithic. Understanding the different risk categories helps you evaluate protocols systematically and identify specific weaknesses before committing capital.
Smart Contract Risk
Code vulnerabilities, logic errors, reentrancy, and upgradability risks. The #1 cause of DeFi losses.
Economic Risk
Tokenomics flaws, unsustainable yields, oracle manipulation, and flash loan attack vectors.
Operational Risk
Admin key compromises, team exits, centralization points, and governance attacks.
Market Risk
Impermanent loss, liquidation cascades, liquidity crunches, and correlation risk.
Smart Contract Risk Analysis
Smart contract exploits have caused over $5 billion in losses. Here's how professionals assess code risk:
2+ independent audits from reputable firms
Trail of Bits, OpenZeppelin, Consensys, Spearbit tier
Critical/high issues fixed and verified
Audited after major updates, within 6 months
Audit Limitations
Audits are point-in-time reviews. They don't cover: post-audit code changes, economic attack vectors, oracle manipulation, governance attacks, or admin key compromises. Never rely solely on "audited" status.
Economic & Design Risk
Even perfectly coded protocols can fail due to flawed economic design. The "DeFi death spiral" has claimed numerous protocols with unsustainable tokenomics.
Economic Red Flags
Unsustainable APY
APY > 100% without clear revenue source = paid from token emissions = dilution = price death spiral
Ponzinomics
New deposits needed to pay existing yields. Collapses when growth slows.
Oracle Dependency
Single oracle source without manipulation protections = flashloan attack vector
Liquidity Concentration
If 1-2 LPs can drain the pool, exit liquidity becomes zero in crisis
Ask: Where does the yield come from? Legitimate sources include: trading fees, lending interest, liquidation penalties, and protocol service fees. Suspicious sources: only token emissions with no buyback mechanism.
Team & Operational Risk
The people behind a protocol matter. Anonymous teams aren't automatically bad (Satoshi was anonymous), but lack of accountability increases rug risk.
Team Assessment
- • Publicly known identities with verifiable history
- • Previous successful projects or employment at reputable companies
- • Active community engagement and transparent communication
- • Clear response protocol for security incidents
Admin Key Controls
- • Multi-sig wallets with 3/5 or higher threshold
- • Timelock on critical functions (24-72 hours)
- • No single admin can drain funds or change rates
- • Upgrade patterns with delay and veto mechanisms
Risk Scoring Framework
Professional risk scoring aggregates multiple factors into a weighted composite score. Here's a framework used by DeFi funds:
Weighted Risk Factors
Score Interpretation
Risk Assessment Tools
Use these tools together for comprehensive due diligence:
DeFiLlama
TVL history, hack database, protocol comparisons
DeBank
Protocol rankings, smart contract verification
Etherscan/Solscan
Contract verification, admin key analysis
Rekt News
Hack history, post-mortems, leaderboard
Interactive Risk Scorer
Use this tool to score DeFi protocols against our risk framework:
Aave V3
TVL: $12.50B
Auditors
Risk Assessment Framework
- • Audit Score: Number and quality of security audits
- • Code Maturity: Time in production, battle-tested
- • Oracle Risk: Dependency on external price feeds
- • Team Risk: Anonymity, track record, token distribution
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Frequently Asked Questions
The main DeFi risks are: smart contract bugs/exploits (code vulnerabilities), economic attacks (oracle manipulation, flash loans), rug pulls (malicious team exits), regulatory risk, and market/liquidity risk. Smart contract risk is usually the highest for new protocols.
Check for: multiple audits from reputable firms (Trail of Bits, OpenZeppelin, Consensys), bug bounty programs, time in production without incidents, TVL stability, team transparency (doxxed or well-known), and code verification on block explorers. Also review their incident response history.
A DeFi safety score aggregates multiple risk factors into a single rating. It typically includes audit status, code quality, team reputation, TVL, time live, admin key controls, and historical incidents. Scores range from 0-100 or use letter grades (A-F).
No. Audits reduce risk but don't eliminate it. Many hacked protocols had audits. Audits only cover the code at a specific time, can miss issues, and don't cover economic attacks or admin key compromises. Treat audits as one factor, not a guarantee.
Red flags include: anonymous teams, locked/renounced ownership claims (verify on-chain), unrealistic APYs, no audits, rushed launches, admin keys with full withdrawal access, and poor documentation. Stick to established protocols with track records and diversify.