4 Steps to Screen for Security on the Crypto Front
As much as I love crypto, I have to admit it can be a dangerous place.
Both individuals and large corporations can seriously financially injure investors. More than anything, investors need to be careful and always do their due diligence, lest they part ways with their hard-earned crypto forever.
To get some idea on how to stay safe in the Wild, Wild West of crypto — and weed out weak, unworthy projects — I've spoken to Brandon Tucker, growth lead at Marinade Finance, Solana's (SOL, Unrated) No. 1 project by total value locked.
Brandon said that it's crucial for investors to take a thorough look at the security measures a crypto project has in place before investing. That process can be broken down in four steps.
Step 1 of a thorough review is to look at whether the project's smart contract has been audited by reputable firms and if these audits are available for public viewing.
Multiple updates from trusted firms are a great sign, especially if the project has posted them in their documentation for transparency.
Step 2 is to review a project's code. To do this, you can seek out a project's Github repository and look at who's building on it and what kind of development activity is taking place.
A red flag here would be if you can't review the code because it's closed source. Closed-source code can be dangerous as there may be hidden vulnerabilities that are not visible to the public.
Step 3 is to understand the protocol's multi-signature … and who's involved in it.
A multi-signature — or multi-sig — protocol is a type of digital signature scheme that allows multiple parties to sign a transaction. In the context of cryptos and blockchains, a multi-sig protocol is a way to secure a wallet or smart contract by requiring more than one signature, or key, to authorize a transaction.
Put simply, it requires multiple individuals or entities to provide their own unique signature to authorize a transaction, making it much more difficult for a single individual or entity to steal or misuse the funds. In the past, lack of transparency regarding who controls a project's smart contract has led to panic and uncertainty in the community. Therefore, it's important to know who's in control of the smart contract and what kind of safeguards are in place to protect it.
Protocols and smart contracts are at the heart of DeFi projects. The more layers are on top of one another, the more potential there is for someone to find a flaw in the security.
That's why understanding the complexity of a project, as well as its multi-sig protocol, is key to evaluating a project's ability to protect itself against bad actors.
Step 4 is to be aware of token economics and to understand if the yield is sustainable or not.
To that end, you should follow the money, as it were, in order to discover where any yield for liquidity providers is coming from, and what token is being used to pay those rewards.
You need to look no further than many of the centralized platforms that collapsed in 2022 to see what can happen when the high yields promised are unsustainable.
Investors should be cautious of too-good-to-be-true annual percentage yields. Often, they do turn out to be far too risky.
Additionally, it's important to understand the concept of impermanent loss when supplying tokens to a liquidity pool.
Impermanent loss happens when you deposit assets into a pool and the value of those assets turns out to be lower when you withdraw them later, compared to if you had just held onto them. It's crucial to note that this type of loss can occur even if you don't lose money.
Ideally, this is offset by the yield you've earned on your deposited crypto. If it's not, then your overall gains could end up smaller than if you had tried to time the market and sold at a high.
As crypto investors, it's our responsibility to stay informed and protect ourselves from potential pitfalls. These four steps will go a long way in helping investors sort out which projects hold real promise ... and which are hiding fundamental problems.
I'm grateful to have had the opportunity to speak with Brandon and gain valuable insights on how you can reduce your risk while still participating in the ever-evolving crypto landscape.
We hope you found this information useful, and we encourage you to reach out to us on Twitter via @WeissCrypto if you have any questions or comments.
Best,
Jurica
