MCS | DeFi Series Part 5: Risk & Challenges

MCS | DeFi Series Part 5: Risk & Challenges


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Although the technology is still relatively young, it is almost impossible to disagree that blockchain technology and its potential uses are game-changer disrupting the current financial system. In this article, let's explore the risk and challenges of DeFi.

Technical Risk

In 2016, a decentralized autonomous organization (DAO) was hacked in which $50 million in Ether was stolen, and in 2020, it was estimated about $120 million was stolen from DeFi protocols in 15 separate attacks. Although smart contract security has improved since then, hackers can still target other vulnerabilities such as stealing access to the code from the founder's computer. Apart from that, the limitation of blockchain technology also contributes to network congestion, which can lead to high network transaction fees, failed transactions, and liquidation issues.

Asset Risk

In 2018, the price of Bitcoin crashed more than 80%, from $20k to a little over $3k. The collateral pledged in DeFi transactions usually uses cryptocurrency, and the protocols are often built on the Ethereum blockchain. The possibility of the collateral declining sharply is high due to the crypto market well-known volatility. Furthermore, the market tends to receive effects from social influence. For example, the Bitcoin price dropped significantly after Tesla's announcement to scale back on their Bitcoin holdings. While panic buying of the crypto asset drives up the price, panic selling of DeFi tokens can cause major crashes that would be highly unusual with fiat currency.

Liquidity Risk

In March 2020, COVID-19 caused the cryptocurrency market to experience a crash of almost 40% when the global stock market dropped. An example of a liquidity risk during that time was the congestion problems on the Ethereum blockchain. When the network is crowded, it will create arbitrageurs, and liquidity suppliers will not be able to keep rates consistent across platforms, resulting in significant dislocation on individual exchanges and market drop. Transaction charges increase simultaneously with the time it takes to complete the transaction block.

Regulation Risk

El Salvador has become the first country in the world to legalized Bitcoin as its legal tender. Despite positive acceptance, cryptocurrency and DeFi assets are still not defined in terms of taxation in most countries. According to Statista, DeFi market capitalization accounts for approximately 3% of the overall cryptocurrency market cap worldwide this year, which is negligible compared to the world financial markets. China's Cryptocurrency Ban on the 24th of September triggered a massive sell-off of cryptocurrency, and the price of Bitcoin fell below $41k. In the long run, however, if properly planned and implemented, cryptocurrency-related policies in various countries around the world may be helpful for the healthy development of the cryptocurrency market.


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MCS Team

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