Some hard and fast rules to avoid defeat during this critical time
When an investor or DeFi protocol gets REKT in crypto, it means they got wiped out and lost a lot or all their money. When the price of crypto keeps climbing higher and higher, and excitement takes hold, this can quickly happen even to the most hardened traders.
Continuous hype and increasing value can build a false sense of security that strong-minded traders ignore despite knowing a drop is inevitable. Moreover, it’s vital to understand that markets move in cycles and that the old saying ‘if it looks too good to be true, it probably is’ is very relevant.
Importantly, it’s not only individuals that can get REKT. In the first half of 2022, we have seen dapps, centralized finance apps, DeFi, VCs, hedge funds, and all parts of the industry report significant losses.
This article looks at ways to stay safe and avoid getting REKT in crypto and when using DeFi.
- Stick to trusted, well-used DeFi protocols
- Understand where the yield or reward comes from
- Dont forget gas costs when estimating returns
- Understand basic tokenomics
- Use leverage with extreme caution
- Understanding impermanent loss
- Consider passive earning opportunities
Stick to trusted, well-used DeFi protocols
DappRadar can help you here as an investor. We track thousands of DeFi dapps across multiple blockchains and rank them by the number of unique active wallets interacting with them and by their total value locked (TVL) metric. In general, the more TVL and engaged users over a long time frame, the safer the platform, although there are exceptions to that rule.
Another part is to build positions on established and audited protocols with reputable teams working behind the scenes to lower the risk of bugs, exploits, or hacks. Moreover, decentralized finance providers are more transparent than centralized platforms, which can give you more insight into the overall health of a dapp. You can see a list of the top DeFi protocols here on DappRadar.
Understand where the yield or reward comes from
Some yields are used as marketing gimmicks to incentivize users for a short period of time and are ultimately unsustainable. Alternatively, they can be inflationary with the protocol creating new tokens at will. These yields are not sustainable.
For example, a new DeFi protocol launches, offering 500% rewards in their newly minted token for providing liquidity in ETH on the platform. Looks too good to be true, right? Well, it is because the more people jump into the pool, the lower the rewards get, plus rewards in the platform’s native token could end up being worth nothing if the platform fails.
Not to mention the transaction fees to get involved in the first place and the chance of a rug-pull. In essence, investors risk lending an asset with value such as ETH or BNB for rewards in an unknown token.
Understanding how a yield is generated under the hood is vital to assessing its stability. If one protocol offers 5% and the other offers 10%, ask yourself how, and remember that higher rewards often have higher risks attached and can also be decreased without much warning.
Dont forget gas costs when estimating returns
Gas costs can be easily forgotten but can ultimately kill profit margins. On Ethereum, gas fees can be high, resulting in any position requiring multiple transactions eating a significant amount in gas costs and the final margin.
In general, investors playing with less than $1000 would be better to go to work on chains like Avalanche, Polygon, BNB chain, or Solana, where fees are minimal and you don’t end up giving away 30/40% of your $1000 in fees. This can be the case when using Ethereum dapps.
For example, creating liquidity provider (LP) tokens costs money. Adding LP tokens also has a fee. Then at the back end, there are fees for removing liquidity and harvesting and ending an LP position. These days, the costs often outweigh the gains on Ethereum. Hence the rise of Layer-1 and 2 solutions to help DeFi scale.
One straightforward option is to look into making transactions at times of the day when gas is the cheapest on Ethereum. Secondly, an increasingly popular option is to consider alternative Layer 1 blockchains and Layer 2 scaling solutions like BNB Chain, Polygon, and Solana where transactions are a fraction of the cost of those on Ethereum.
Understand basic tokenomics
Tokenomics refer to the economic properties of a token and contain a range of qualities such as emission rate, supply, vesting schedule, and more. Arguably, understanding the tokenomics of a project is by far one of the most challenging things to do, moreover, It is often discussed but seldom understood.
In a nutshell, projects with well-designed tokenomics are much more likely to succeed in the long run, whereas projects with poor tokenomics are bound to fail.
New investors often get REKT because they fail to grasp the tokenomics of the project, but also because they fail to differentiate the good projects from the bad. Or, they simply chase high yields without considering the risks or giving credence to the idea that there could be risks!
Knowing the token supply is crucial as it directly impacts the perceived value of the token. The perceived value might increase or decrease depending on how scarce the tokens are.
When the token supply is low, it is automatically deemed more valuable, and vice versa. However, the perceived value of the token is not automatically higher because it is scarce, and four key metrics to look out for are:
- Circulating supply
- Maximum supply
- Market cap
- Fully diluted market cap
All four are covered in detail in our ultimate guide to DeFi. Importantly, supply and demand determine a token’s price. An increase in the supply of tokens and a drop in demand would result in the token price dropping, which is a common scenario in the crypto space, especially in DeFi and yield farming protocols.
If tokens are continually rewarded then the supply increases, if demand then drops, there’s a big problem.
On the flip side, some genuinely outstanding projects can build demand for their token, so the increased supply is offset by even higher demand. These are just some basic tokenomics frameworks to look out for when evaluating projects. Other factors also exist, but the above is an excellent place to start.
Use leverage with extreme caution
Leverage can certainly increase returns but comes with much higher risk and requires active monitoring. Leverage is borrowing assets to build more significant positions, and rewards should the position build favorable outcomes.
However, miscalculations can lead to possible liquidations and getting REKT. We cannot state firmly enough that using leverage or borrowing is not for passive or newbie investors.
The main issue is that crypto investments are volatile. If, for example, your collateral loses value, your borrow balance may exceed the limit, increasing your risk of getting liquidated and losing some or all of your collateral. If you choose to engage in leverage, then alongside monitoring the position, here are a few tips to avoid getting REKT and avoid liquidation:
- Be conservative and avoid borrowing up to your maximum limit.
- Use stablecoins as collateral since they generally don’t fluctuate in price.
- Monitor the health of your loans and add more collateral if required
A quick example of how things can go wrong could be that a user deposits ETH as collateral on Monday and lends USDC against that value. Then, on Tuesday, the worth of ETH dropped 40%, and now they have 40% more USDC than they secured with their collateral. Choices are now limited, so it’s highly recommended to use stablecoins as collateral to avoid this situation.
Understanding impermanent loss
When traders deposit tokens into a liquidity pool and the price changes a few days later, the amount of money lost due to that change is your impermanent loss. Stablecoins, for example, will stay in a relatively contained price range. In this case, liquidity providers have a more negligible risk of impermanent loss.
Many liquidity providers experience impermanent loss, which outweighs the transaction fees.
However, the impermanent loss can be counteracted by trading fees like on Uniswap, for example, where pools exposed to impermanent loss can still be profitable thanks to the trading fees. However, this depends on the protocol, the exact pool, the deposited assets, and even wider market conditions.
Consider passive earning opportunities
After reading through the risks and how to avoid getting REKT in crypto, we wouldn’t be doing our job correctly if we didn’t highlight safer, less volatile alternatives to earning. Moreover, passive opportunities that don’t involve such a heavy time investment are suitable for those with no time to check their portfolio constantly.
Single token staking has become a popular option amongst crypto newbies as most centralized and decentralized platforms offer it in some form. The most popular is stablecoin staking which can return investors around 5% and provide some hedge against rising inflation and the devaluation of domestic currencies.
The process is simple, stake the asset for a fixed term and collect weekly rewards based on an APY.
Yield aggregators are also a great alternative to hands-on yield farming. Platforms like Yearn can create a risk-adjusted return for you with little effort on your end. Another rising trend is Index funds, which allow investors to gain exposure to a basket of tokens for a low fee.
Index funds can give traders diversification in a single transaction, and more importantly, the platform handles rebalances so that users can avoid gas fees.
Avoid Getting REKT
To dive deeper into these topics check out our ultimate guide to DeFi.