Does DeFi offer investors higher returns with no middlemen or a higher risk of fraud?

Decentralized finance — or DeFi for short — is the name that’s been given to a variety of new applications designed specifically to disrupt the historic structure of the financial market.

The theory behind DeFi is based on blockchain, technology that allows a number of parties to share ownership of a series of transactions so that they aren’t controlled a single entity. Blockchain was quickly taken up by bitcoin as because it takes away any human delays, speeding up transactions and allowing users greater control over their assets.

DeFi takes this one step further.

Bitcoin had already cut out the middlemen — for example the credit card and digital payment companies — by allowing users to manage their own direct purchases, free from having the possibility of these middle stopping or even recording the transaction.

Similarly, blockchain has also taken the need to go through a middleman out of loans, insurance, crowdfunding and financial trading.

DeFi, however, has now given blockchain the power to offer even more intricate financial uses.

As the majority of DeFi applications are built on Ethereum, the world’s second-largest cryptocurrency platform, it is easier for users to create the highly intricate smart contracts required to oversee and execute a range of increasingly innovative decentralized applications.

Up until now the most common uses of DeFi have included:

  • Decentralized exchanges (DEXs) that help users exchange currencies or cryptocurrencies for other currencies or cryptocurrencies without having to pay an intermediary
  • Trading stablecoins, a cryptocurrency backed by a fiat currency to make the price more stable
  • Lending platforms that use smart contracts to replace the usual intermediaries
  • ‘Wrapped’ bitcoins (WBTC). This allows you to send bitcoin directly into the Ethereum system so it can be used directly within a DeFi system and, once it’s in, can earn the owners interest should they choose to lend their bitcoin via a decentralized lending platform
  • Prediction markets that allow you to bet on the outcome of future events like elections without having to go through an existing betting platform

However, there is now a second generation of applications coming through and the ones that are creating a particular buzz at the moment are:

  • Yield farming allows more experienced traders to scan through the various DeFi tokens to find the largest potential returns
  • Liquidity mining, a form of yield farming that entices users with the offer of free tokens
  • Composability; as DeFi apps are open source, the code is public which means entrepreneurs can use the existing apps to create new applications of their own

Although the tech is exciting and the possibility of being able to cut out the middlemen (and their commission) is attractive, if DeFi is going to realise its potential it has to be able to make users money.

Reportedly Ethereum DeFi projects are making users a lot of money. However, the real attraction is that a lot of the return is coming from passive income streams like generating interest on loans rather than from standard trades. And of course, the greater the return, the greater the risk which takes us to our next — and possibly most important — point.

DeFi is most definitely a risky business.

While there have been huge returns, your safety will still depend on your ability to separate the good projects from the bad. During 2020 a number of DeFi applications have already imploded. The YAM coin crashed taking its market cap from$60m to $0 in little over half an hour. Hotdog and Pizza soon followed suit costing investors millions.

Also, as the applications are built on blockchains, if the smart contracts contain even the smallest error there is no opportunity to rectify the mistake and that bug could well end up costing users dearly.

More worryingly two high profile frauds recently hit the headlines. This indicates there is something much darker than bad luck and bad coding to worry about.

Firstly a leaked Telegram discussion between 50 well known crypto figures catalogued their plan to scam unsuspecting DeFi investors using the worthless $Few token. They were going to use their position as influencers to promote $Few on Twitter then once it had gained some traction, they’d dump their coins while the price was at its highest.

Fortunately the backlash from the screenshots that appeared on social media collapsed the plot.

Meanwhile, a new liquidity mining pool, Yfdexf.Finance, was forced to fold after defrauding investors of $20m although as soon as reports surfaced and the crypto-media tried to find out more, all traces of the scam had been wiped.

If you are attracted by the potential rewards offered by DeFi we’d be pleased to share some tips to help you identify whether the opportunity you’re considering might be a scam.

Although as solicitors and litigators our bread and butter is helping clients resolve disputes and recover the funds they’ve lost as a result of fraud (and in particular from scams involving bitcoin, cryptocurrency and every other type of digital investment), our experience has also taught us how to spot a potential fraud.

Or, if you have been the victim of a DeFi scam and don’t know what to do next, contact us. We will talk you though the next steps.

It doesn’t matter who is behind it or which legal jurisdiction they are in, we have a long, successful and demonstrable track record of resolving cryptocurrency disputes and know exactly what is required to maximise the likelihood of you recovering the money you have been cheated out of.

If you would like to discuss anything related to decentralized finance (or anything related to bitcoin, cryptocurrency or digital fraud) please call us today on 020 7792 5649 or email us at info@selachii.com.

We will help.

Selachii is a modern commercial law firm, specialising in litigation and dispute resolution, helping businesses and their owners to achieve their objectives