DeFi investments are full of pitfalls! Let's take a look at the 17 common mistakes.
The reason experts become experts is because they have made all the mistakes in their field that can be made. However, in the world of DeFi, a momentary mistake can result in significant financial consequences, and it may not even be clear what caused the mistake. Recently, DeFi researcher The DeFi Edge compiled a list of 17 common mistakes. Let's take a look at these issues that may have happened to you!
Source: The DeFi Edge
Table of Contents
17 Common Mistakes in DeFi Investments
1. Overly Trusting Alphas Found Online
Your favorite Youtuber gave you Alpha information about a protocol, and then the token price of that protocol plummeted within a few hours. You need to understand that retail investors are at the bottom of the food chain:
- Layer 1: Builders
- Layer 2: Venture capitalists and insiders
- Layer 3: Whales
- Layer 4: Key Opinion Leaders (KOLs)
- And then comes you, at the bottom
2. Not Calculating the Risk of Venture Capital Dumping
Token prices obtained by capitalists or venture capital institutions are much lower than those of retail investors. As long as they sell the tokens, it will inevitably lead to a price drop. Therefore, understanding the initial token distribution and unlocking time is crucial.
However, this does not mean completely avoiding insiders or venture capitalists holding too much of the token. Take Solana, for example, which has a large number of venture capital investments behind it, providing not only funds but also development advice.
3. Chasing Inflationary Tokens with High APR
A 25,000% APR may seem enticing, but without practical utility and stable cash inflows, the prices of these inflationary tokens often tend to collapse. Ironically, stablecoins like UST with a 19.5% APY perform better than these high-inflation tokens.
4. Ponzi Economics
Some projects are purely Ponzi schemes. If you do not know the utility of their tokens, they are likely to be Ponzi schemes.
However, this does not mean you cannot profit from them. As long as you ensure that you are an early entrant and gradually realize profits during the process.
5. Not Knowing When to Take Profits
"If this profit model can continue for a few more months, I won't have to worry about food and clothing for the rest of my life."
When you start to think you are a genius, remember to take your profits. Use systems and formulas to control your emotions.
6. Underestimating the Next Trend
- DeFi 1.0 -> DeFi 2.0
- Dogecoin -> Shiba Inu Coin
- ETH -> Solunavax Solana, Luna, Avax
- Cryptopunks -> Bored Ape Yacht Club
The new generation missed the advantage of early entry, but they will chase and create new trends.
7. Blindly Following Market Narratives
Narratives refer to the current market sentiment about an industry or protocol.
Q4 21: Fork versions of OHM are killing OHM
Q1 22: OHM fork is dead
However, these market narratives change rapidly, so judgment should be exercised cautiously.
8. Ignoring Slippage
You want to exchange X tokens worth $100 for Y tokens worth $100. After submitting the transaction, you end up with Y tokens worth $80. Why? Because slippage occurred.
Low trading volume and low liquidity can cause more significant price fluctuations. Choose a DEX with high liquidity and adjust the slippage tolerance to avoid this situation.
9. Not Accounting for Impermanent Loss
When providing liquidity to a pool, the value of the two tokens must be 50:50. When token prices fluctuate later, with one going up and the other going down, AMM will rebalance by selling the higher-priced token.
Choosing tokens with high correlation can reduce losses from this situation. Additionally, impermanent loss should be considered when calculating APR.
10. Ignoring Market Cycles
Understand which stage of the market cycle the current market is in. If the market is bearish, the allocation of stablecoins should be higher. When the market is bullish, shift to higher-risk investments.
11. Risks of Automatic Compounding
To maximize DeFi farming returns, in the past, daily earnings needed to be withdrawn and reinvested. However, the automatic compounding feature solves this issue but also increases the risk of being exploited by hackers.
Pancakebunny and Grim finance were victims last year. If you want to use this feature, ensure you use audited DeFi protocols like Beefy finance or Reaper Fram, etc.
12. Overly Aggressive Portfolio
Cryptocurrencies with lower market values indeed have the potential to multiply hundreds of times. However, a sudden and severe crash could easily wipe out past gains. Allocating stablecoins and blue-chip coins in the investment portfolio can hedge against this risk.
13. Overly Diversified Portfolio
It is not recommended to over-diversify your investment portfolio. If one token has a staggering price increase but a small weightage, the gains may not be substantial. It is best to limit the number of tokens in the portfolio to 7-12.
14. Overly Concentrated Portfolio
Contrary to the previous point, an overly concentrated portfolio is also not a good approach. It is best to set a maximum percentage limit for a single asset in the portfolio; The DeFi Edge suggests 15%.
If the weightage of a single asset exceeds 15% due to a price increase, consider taking partial profits and readjusting the position.
15. Unwillingness to Stop Loss
HODL is a dangerous mentality. If a token's price drops, it is best to research and understand the reasons behind it.
Even if the token has dropped by over 50%, it is still far from dropping by 95%. The remaining assets can still be used elsewhere. Preserve your assets, and you won't have to worry about running out of fuel.
16. Blindly Trusting Influential Individuals
These individuals may include certain KOLs or influencers who promote a token as the best thing ever but will never disclose that they are being compensated for it. Be cautious of what they say and conduct your own research; it is the most responsible way to manage your assets.
17. Underestimating the Benefits of Marketing
Some teams focus 100% on development and neglect marketing entirely. However, teams lacking in marketing will struggle to attract funds. Nike and Apple reached the pinnacle because of good products + good marketing. Both are indispensable.