A number of sensational hacks, including the recent $ 610 million raid on PolyNetwork, have sparked speculation that the rapid pace of growth is making DeFi (decentralized finance) increasingly vulnerable. Driven by the increasing demand for funds outside of the KYC network, the DeFi segment has grown exponentially and is valued at over $ 108 billion, according to an estimate by the DappRadar website. Given the frequency of the hacks, security is a growing concern for the DeFi community.
The hackers, who are returning all of Poly Network’s loot, do not lessen the severity of the breach. It only adds to DeFis’s weaknesses.
A gaping regulatory vacuum, inadequate safety audit processes and a high pace of innovation are the main challenges for DeFis. Experts believe slowing the pace of development will pay off as the DeFi ecosystem matures and becomes a target of hostile access.
A report from crypto-intelligence firm CipherTrace said DeFi hacks totaled $ 360 million in July (apparently before the $ 600 million Poly Network episode in August). That was around 75% of total wealth lost to hackers in 2021, which is already a 2.7-fold increase over 2020 as a whole, jumping from 3% in 2020.
While the crypto world has been rocked by a number of high-profile DeFi hacks, there are some who view the worrying development as a hidden blessing. They see the proliferation of hacks as evidence of the need for more robust security. According to John Jefferies, the fact that an anonymous hacker can loot millions of dollars from unnamed individuals shows that the system needs stronger security. He sees any regulatory change that requires better KYC standards in decentralized exchanges (DEX) including DeFi as a positive move. Therefore, from a utilitarian perspective, hacks can have a positive impact on the segment.
Predictive risk and intelligence platform Merkel Science says the lack of KYC gives bad characters access to massive funding. The lack of KYC also increases financial risk, forcing funding agencies to seek unusually strong collateral.
The fundamental nature of DeFi as a decentralized platform appears to make it difficult to enforce anti-money laundering (AML) laws.
Unlike centralized exchanges (CEXs), DeFi protocols perform alternative processes compared to traditional financial systems, replacing intermediaries with smart contracts, which are self-sufficient codes that reside on blockchains. At no point do DEXs own users’ funds, which makes KYC pointless? However, DeFi protocols are at risk if the smart contract holder’s security key is compromised. In such a case, the entire economy based on this protocol could be at risk, says Lior Lamech, founder and CEO of cybersecurity company GK8. Lamech isn’t a big fan of the sanctity of the decentralized nature of DeFi protocols. For him they are not really decentralized due to the control that the owner of the smart contract has over the processes.
Jefferies believes regulatory pressures will eventually lead to KYC and the cleanup of the DEX room. This is because federal regulators generally support DeFis. âA lot of people in the US government think DeFi is a real innovation,â and the cleanup would almost make DeFi a success, he says.
Federal regulators around the world are aware of the growing link between money laundering, terrorist financing, and other illegal activities. The updated guidance from the latest FATF or Financial Action Task Force takes an in-depth look at virtual assets and virtual asset service providers, or VASPs.
However, regulators are faced with the difficult task of snapping up the intermediaries responsible for KYC and AML compliance in a truly decentralized process, according to the new report from Merkel Science. The challenges for decentralized VASPs become even more difficult when complying with the updated Travel Rule, which was formulated without taking the DeFi ecosystem into account. The FATF didn’t even complete the task of classifying DEXs as VASPs. Until then, it is unlikely that DeFis will be brought into a meaningful regulatory framework.
Additionally, there are many regulatory skeptics in the DeFi ecosystem like Mitchell Amador, CEO of Immunefi, a bug bounty platform for DeFi protocols, who confided to Cointelegraph that regulation is unlikely to have much of an impact on DeFiâs future. Amador wants better security practices to reduce DeFi-related crime. According to the expert, hacks will continue to exist, but as the DeFi ecosystem adapts, they are becoming more and more difficult.
There are some experts who believe that DeFi storage space requirements Slowing down development cycles taking into account the frequency of the hacks. Amador is among those who believe that the incorrectly verified codes are more susceptible than those that have been tested over a long period of time. This requires a slower development cycle. A thriving bug bounty program is also important, as vulnerabilities must be tackled with the hat of the hackers. Jefferies sees more robust processes in the crypto industry in 12 months, mainly due to the hacks.