August 11, 2022

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DeFi fraud and theft losses reach $10.5 billion in 2021

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As regulators hone their focus on Decentralised Finance (DeFi), new data from Elliptic reveals that just over $12 billion in losses have been suffered over the past year by DeFi users and investors.

DeFI defines a flourishing alternative financial system that replaces traditional intermediaries with software running on blockchains.

According to the Elliptic report, the prevalence of DeFi theft and crime is largely due to the untested and immature nature of the technology available. Mistakes in the design and development of decentralized apps are the most common cause, giving rise to bugs which hackers can exploit, accounting for $10.8 billion of all losses.

Another $1 billion in losses are the result of exit scams (where a Decentralised App creator intentionally leaves a ‘backdoor’ in the code that allows them to steal users’ funds) and the theft of ‘admin keys’.

“Decentralised apps are designed to be trustless in that they eliminate any third-party control of users’ funds”, says Tom Robinson, chief scientist at Elliptic. “But you must still trust that the creators of the protocol have not made a coding or design mistake that could lead to a loss of funds.”

This was an issue recently highlighted by Bank of England deputy governor for financial stability Jon Cunliffe who observed that the highly decentralised and global structure of the DeFi sector along with the difficulty to trace end users provide a unique set of challenges for regulators.

“Even on an initial view it is clear that the sector is opaque, complex and undertakes financial activities that carry risk – activities that are regulated with the traditional financial sector,” he said. “There are pronounced market integrity challenges given the absence of investor protection, AML and other market integrity provisions.”

Similar concerns were recently aired by SEC commissioner Caroline Crenshaw, writing in the International Journal of Blockchain Law, who argued that lack of transparency and psuedonymity represented critical structural problems that the DeFi community needs to address.

As Elliptic’s Robinson emphasises: “We are still at the experimental stage and DeFI users face significant risks. As the technology matures and becomes better-regulated, losses will fall and DeFi will become a practical alternative to the banks, asset managers and exchanges that we currently rely upon.”

By: Sheila Satori Mensa

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