DeFi Lending Audits 101
To ensure that worst doesn’t come to worst, deep evaluations of the financial algorithms, structure, and coding of a platform must be executed every now and then. It’s the standard for any software in general to prod their app or website for holes that can be abused, especially when it comes to people’s money. Users look for this to make sure the platform is serious and as vigilant as can be when it comes to keeping out criminals.
With the vast fortunes the TVL of DeFi systems hold, just a tiny crack in the armor can be enough for someone to pry open the door and forever tarnish general public trust in an organization.
A proper audit means going above and beyond in due diligence, looking thoroughly for any little bugs or vulnerabilities, and checking on the interoperation of a platform’s protocols.
This involves ensuring operations like collateral management, liquidation procedures, and interest calculation are exploitability-free for lending protocols.
Thorough checks the best aspect of risk management. They decrease the probability of successful cyber attacks by staying friendly to constant protocol refinements that maintain the general integrity of DeFi lending architecture.
Another way to safeguard your investments is by diversifying and crowdlending is one of the most profitable ways of doing so. Nowadays, credit applicants who previously couldn’t get a loan now get vetted by advanced credit scoring technology and approved for loans contributed to by a multitude of lenders at once, all sharing the risk. On top of that, a lot of these loans are backed by borrower collateral. One such innovative, environmentally friendly example is the Swiss 8lends.
Audits Breakdown
They maintain a range of crucial steps to safeguard DeFi lending environments.
- Code Review: You don’t want integers overflowing, reentrancy going on, or any kind of logical inconsistencies or loopholes. Auditors need to comb through all the lines to determine exact lines whose coding could theoretically prove vulnerable. Exhaustive manual and automated testing ensure that each function performs as desired.
- Testing and Simulation: Apart from static code reviews, the auditors also simulate real scenarios by conducting stress tests and simulating likely attack vectors. Through this, the protocol's response to different scenarios, for instance, unusual market volatility, flash loan attacks, or a surge of user traffic, can be ascertained.
- Risk Assessment: After identifying vulnerabilities, auditors examine their impact and severity. This risk grading process allows teams to address the most critical vulnerabilities before going live.
- Financial Modeling: Since lending apps are multifaceted, audits are more than code auditing. Auditors examine the economic rationale behind interest rates, collateral multiples, and liquidation triggers to ensure they are soundly robust against market manipulation and edge cases.
- Remediation Suggestions: After thorough analysis, auditors release a thorough analysis document outlining the faults identified, severity, and remediation some suggestions. Open breakdowns facilitate the correction of faults and win community trust by demonstrating proper risk management.
Evidence from large-scale research by HKUST researchers into auditing decentralized finance protocols proves the efficacy of such audits in exposing inherent weaknesses.
Material Weaknesses in DeFi Lending
DeFi credit apps come with a characteristic set of weaknesses that distinguish them from other blockchain uses. Some of the most prevalent weaknesses are below.
Reentrancy Attacks
These are among the most infamous schemes. In these attacks, a contract calls an external contract repeatedly prior to altering its state. The attacks are responsible for a DAO hack.
Not addressing these attacks can turn them into a significant threat to modern-day lending platforms.
Flash Loan Misuses
Flash loans facilitate borrowing without collateral, provided the borrower pays the loan in a single transaction. However, flash loans, new as they are, can be used to front-run or drain liquidity pools if underlying protocols are not adequately secured.
Liquidation Process Risks
Timely and sequential liquidations are essential to the solvency of lending protocols. If timing mismatch or market data can be manipulated by an attacker, cascading liquidations and huge user losses will be imminent.
Oracle Manipulation
Most lending protocols rely on external price feeds, or oracles, to price collateral. If hackers compromise one oracle, attackers can manipulate asset prices to initiate unfair liquidations at the system's expense.
The vulnerabilities thus warrant the audits. Through stringent testing and careful examination, auditors can detect possible vulnerabilities much earlier than attackers can prey on them, thus rendering the environment secure for users.
The Auditing Process and Methodology
Auditing protocols in DeFi is challenging since blockchain technology is immutable & decentralized. Altering a smart contract after its publication on the network with no central authority is time-consuming and cumbersome. For that reason, robust pre-deployment audits prove even more crucial.
As per norms established in academic research, e.g., remarks by the HKUST study on "Auditing Decentralized Finance Protocols," auditing is usually a multifaceted process.
Static and Dynamic Analysis
The auditors employ static analysis tools before they go live with any code that filters out known vulnerabilities. The filtering works with dynamic analysis, where the code is executed in controlled environments to observe how it acts under various conditions.
Peer Reviews and Formal Verification
Peer reviews introduce another level of critical scrutiny, since several experts independently peer review the code. Formal verification methods are sometimes applied to prove that the code's critical portions are correct. Formal verification is costly but essential because it ensures that sensitive parts of the code work as expected.
Continuous Monitoring Post-Deployment
Even after an effective audit, the security environment continues to change. Some projects have incorporated real-time monitoring practices to monitor network development, new threats, and intelligent contract behavior in real time. A blend of all these approaches has been able to detect issues early enough in the development cycle and develop resilient protocols that can evolve as the threat situation evolves.
The Benefits of a Deep Audit
Besides the technical benefits, audits reveal a range of higher-level advantages that are crucial to the stability and success of the DeFi platform.
Higher User Trust
Customers are ready to put their money down once they learn that a platform has passed extensive audits. This kind of confidence is necessary to onboard retail users and institutional investors on the platform and, in the end, adoption in the market.
Regulatory Confidence
Since regulators are beginning to examine the DeFi space critically, audited protocols could be a middle ground between innovation and regulation. Such testing can monitor itself and self-regulation could reassure authorities.
Market Stability
Each audit which finds and addresses bugs steadies the entire market. Secure practices lower the chances of exploits on a massive scale with domino effects throughout the ecosystem.
Developer Insights
Audit reports give developers helpful feedback, point out vulnerabilities, and recommend improvements. This continuous feedback loop improves coding practices and creates safer system designs for future projects.
Conclusion
Audits are required to make DeFi lending platforms secure, efficient, and bustling with sound, high-tech financial products. By enabling a rigorous review of smart contract code, economic model analysis, and real-world testing, auditors enable vulnerabilities to be discovered and remediated. Audits are not the silver bullet to decentralized system risk, but they're an essential defense behind user trust, regulator trust, and overall market stability.
If you’re interested in securing not only your smart contracts but your finances as a whole, consider expanding into crowdlending, where you can even out your risk across projects and enjoy collateral-backed lending. If that sounds like something that remotely piques your interest, go to the 8lends site and register your account today.
