Decentralized Finance Risk Management: Comprehensive Considerations from Code to Governance

Decentralized Finance(DeFi) is an important application area of blockchain technology, achieving a decentralized version of traditional financial services through smart contracts. However, the automation and unmanaged characteristics of DeFi also bring unique risk challenges. This article will explore the main types of risks faced by DeFi and propose a comprehensive Risk Management framework.

Major Risk Types of DeFi

1. Code Risks: This includes vulnerabilities that may exist in the underlying blockchain, smart contracts, and wallet software. Historical DAO incidents, recent DEX vulnerability attacks, and various wallet theft incidents fall under this category of risk.

2. Business Risk: Refers to logical vulnerabilities that exist during the business design process, which may be exploited by attackers to carry out reasonable yet harmful operations. For example, the congestion attack suffered by an early game project, and the price manipulation attack suffered by a lending platform due to the use of an insecure oracle.

3. Market Volatility Risk: DeFi protocols may not fully account for extreme market conditions during design, leading to issues such as liquidation during severe fluctuations. The crisis of a stablecoin project on March 12, 2020, is a typical example.

4. Oracle Risk: As a key infrastructure for many DeFi protocols, the security of oracles directly impacts the entire ecosystem. Any oracle with centralized risk could become a target for attacks or a single point of failure.

5. "Technical Agency" Risk: Refers to the potential risks that ordinary users who are not familiar with smart contracts and blockchain technology may face when using interactive tools developed by centralized teams.

Decentralized Finance Risk Management Framework

To address the aforementioned risks, we propose a comprehensive Decentralized Finance risk management framework that covers three stages: pre-event, during-event, and post-event.

Risk Management

The focus is on conducting rigorous formal verification of the contract code. This includes:

• Clearly define the boundaries of the methods, resources, and instructions used in the contract.
• Analyze the mutual influence of these elements in the combination process
• Use only fully validated and boundary-defined method combinations

This approach is closer to mathematical proof rather than traditional software testing methods. High-quality contract development should be based on a combination of rigorously proven methods.

In-Process Management

Mainly includes two aspects:

1. Shutdown Design: Enable the contract to recognize and respond to attack behaviors, including automatic shutdown and governance-triggered shutdown mechanisms.

2. Anomaly Trigger Design: Automatically control and manage unexpected phenomena that occur during contract execution, adjusting risk management parameters through a triggering mechanism.

The adjustment of beta coefficients and the anti-blocking attack mechanism in a certain oracle system are practical examples of this type of design.

Post-Management

Includes the following key links:

1. Code Vulnerability Fixes: Conduct on-chain governance through the Decentralized Autonomous Organization (DAO) to promptly rectify identified vulnerabilities.

2. Governance Asset Protection: In extreme cases, it may be necessary to consider contract forks to protect governance assets.

3. Insurance Mechanism: Provides insurance coverage for potential risks to reduce possible losses.

4. Asset Tracking: Utilize the transparency of blockchain to collaborate with relevant agencies to track stolen or lost assets.

Conclusion

The current understanding and practice of security in the DeFi industry is still in its early stages. To adapt to future developments, we need to introduce more advanced security concepts and technologies, such as boundary analysis, completeness verification, consistency checks, formal verification, downtime mechanisms, anomaly triggering, decentralized governance, and contract forking. Only through continuous innovation and improvement of the risk management framework can we lay a solid foundation for the long-term healthy development of DeFi.