The rise of Decentralized Finance (DeFi) has not only brought a newfound wave of innovation to the broader crypto ecosystem, but also the opportunity for savvy investors to generate staggering returns. 

Like all markets, especially those in a state of adolescence, DeFi’s reward isn’t without its risks. After all, depositing assets in internet protocols is not the same as placing money on a trusted exchange or a bank.  

With this in mind, Kraken Intelligence, our team of in-house research experts, has published their second report in a multi-part “Crypto Yields” series. This time around, the team analyzed the makeup of DeFi lending to help market participants navigate this exciting digital asset sector, offering a digestible and comprehensive assessment of the associated counterparty risk, the expected returns, the liquidity, and the variety of ways DeFi can help you earn on your assets. 

One of the most vulnerable attack vectors is price manipulation – an area we explain in great detail in this report. To further transparency and security with these platforms, Kraken has also released the Oracle, a utility that verifies data used to price DeFi contracts.

By downloading this report, we anticipate you will have a greater understanding of how DeFi markets work, the unique market dynamics of DeFi lending, why DeFi is a promising and rapidly growing part of the industry, and the risks innate to DeFi.

We cover the following opportunities and risks:

• Smart Contracts – As human written code is prone to errors, hackers and malicious actors can take advantage of poorly written code. To mitigate these single points of failure, participants and lending platforms can be proactive in analyzing and managing their level of exposure to such risks. 

• Collateralization – Lending in decentralized finance is only as strong as the source of the liquidity. In times of volatility, liquidity is often put to the test. When market activity picks up, price can fluctuate wildly or funds may not be accessible. To prevent such scenarios, many loan providers are taking proactive steps with overcollateralized loans and dynamic interest rates.

• Counterparty – One way to determine the level of trust the market has placed on a counterparty is by comparing prices on different platforms. Once you identify the risk premium associated with a particular platform, you can decide if continuing to use it is in your best interest.

• Governance – The entity who sets the rules of the platform has a great deal to do with the associated risks. The Maker and Synthetix Foundations are two examples of central structures who through their tokens have transferred power democratically to their respective communities. Changes to the system are now voted on by the community to decentralize the risks of their platforms.

• Liquidity Pools – Price discrepancies in automated market maker exchanges are attractive to arbitrageurs seeking to buy up the difference. That difference eventually creates a permanent loss once the liquidity is withdrawn. Stablecoins have become an attractive solution for these pools as there is less volatility among prices.

If you haven’t already, be sure to check out Kraken Intelligence’s first note in this series, Crypto Yields – A Simple Breakdown.