Like every technology, DEXs come with their unique set of risks. Let’s dive into some of the most prevalent ones.
Smart Contract Risk 📜
One of the most significant risks when dealing with DEXs revolves around smart contracts. These programmable transactions run the entire DEX infrastructure. If there’s a bug in the smart contract code, it might be exploited and lead to substantial losses. Make sure you’re using a DEX that has undergone rigorous smart contract audits to mitigate this risk.
The DAO hack is a classic example of a vulnerability in a smart contract. The Decentralized Autonomous Organization (DAO) was a form of investor-directed venture capital fund, but a bug in its smart contract was exploited by a hacker who siphoned off a third of the DAO’s funds (around $50 million at the time).
Impermanent Loss 🔄
As a liquidity provider in a DEX, you could face what’s known as ‘impermanent loss’. This occurs when the price of your deposited tokens diverges. The larger the divergence, the more you stand to lose. The loss only becomes “permanent” if the prices don’t return to their original state by the time you withdraw your liquidity.
Price Slippage 📉
High market volatility can lead to price slippage on DEXs. Slippage refers to the difference between the expected price of a trade and the price at which it’s executed. While some slippage is common, large amounts can lead to unfavorable trade outcomes.
If you were trying to trade a large amount of a low-liquidity token on a DEX, you could experience severe price slippage. For instance, if you attempted to sell 10,000 tokens of a small project, your sell order could significantly impact the price, causing you to receive less than you anticipated.
