How to choose which protocol to invest in?

The growth of the DeFi ecosystem has led to the emergence of numerous decentralized financial protocols that offer a wide range of investment opportunities. However, choosing which DeFi protocol to invest in can be overwhelming due to the sheer number of options available. In this article, we explore the most important factors to consider when selecting a DeFi protocol to invest in. We will consider the features to consider, the types of protocols and other relevant aspects.

Characteristics to be taken into account

When evaluating a DeFi protocol for investment, it is essential to consider the following key features:

• Functionality of the protocol: What services does the protocol offer? Some protocols are focused on lending and borrowing, while others focus on decentralized exchange, liquidity or even issuing synthetic assets
• Performance and profitability: Analyzes the yield and profitability potential of the protocol. Consider historical returns, interest rates offered and other economic incentives. However, remember that past performance is no guarantee of future results, so a sound analysis is essential.

• Liquidity and trading volume: Liquidity and trading volume are crucial aspects in assessing the ease of transaction and active market in the protocol. Analyze the liquidity available in the protocol by looking at the size of liquidity pools in decentralized exchange (DEX) protocols. In addition, consider the daily or weekly trading volume to get a sense of activity and demand in the protocol. Robust liquidity and volume can indicate investor confidence and the ability to execute transactions efficiently.

• Evaluation of Total Locked Value (TVL) and growth: Total Blocked Value (TVL) is an important indicator for assessing the health and size of a DeFi protocol. TVL represents the number of assets blocked in the protocol and can be an indicator of its popularity and adoption. Analyze the growth in LTV over the past month or months - has there been a steady increase in LTV or have there been significant fluctuations? Evaluate whether the protocol has been successful in attracting new users and increasing its market share.

• Interoperability: Consider protocol interoperability with other platforms and blockchains. A protocol that can easily interact with other DeFi ecosystems will expand your investment options and opportunities.

• Market trends and narratives: Observe whether the protocol is part of a narrative or trend in the DeFi market. For example, yield farming, non-fungible tokens (NFTs) or other themes may be trending. Evaluate whether the protocol aligns with a growing trend and is capturing the interest of the community and investors. However, keep in mind that trends can be volatile and change quickly, so it is important to assess both the current trend and the long-term sustainability of the protocol.

• Team assessment and roadmap: Research the development team behind the protocol and their experience in the DeFi space. Analyze their track record and previous projects they have worked on. Also consider the clarity and feasibility of the protocol roadmap.

• Partnership and collaborations: Consider the protocol's strategic partnerships and collaborations. Collaborations with other prominent protocols or projects can provide synergies and increase adoption of the protocol, which can benefit investors.

• Ease of use and user experience: Evaluate the user experience and ease of use of the protocol. An intuitive protocol with a user-friendly interface can make your investment experience more comfortable and accessible.

Types of protocols

There are different types of DeFi protocols, each with its own functionality and features. Here are some examples of the most important protocol categories:

• Lending and borrowing protocols: These protocols allow users to lend their crypto assets to others in exchange for interest, or borrow assets using their own assets as collateral. It is a way to generate passive income by lending your cryptocurrencies and also to access capital without selling your assets.

• Decentralized Exchange Protocols (DEX): DEX protocols facilitate the direct exchange of cryptocurrencies and tokens between users without the need for intermediaries such as a traditional exchange. This allows for greater privacy and control over transactions and avoids potential security issues associated with centralized exchanges.

• Options and derivatives protocols: Options and derivatives protocols in the cryptocurrency arena are platforms that allow users to create and trade financial contracts based on crypto assets, such as futures and options. Options are contracts that provide investors with the right, but not the obligation, to buy (call option) or sell (put option) an asset at a predetermined price in the future. Derivatives in general allow speculation on price movements without owning the actual asset, being useful for both risk management and speculation in volatile cryptocurrency markets.

• Liquid Staking Protocols: In liquid staking protocols, users lock their cryptographic assets in the network in order to support blockchain operations and maintain its security. In exchange for locking these assets, users receive tokens that represent their participation in the network. These tokens can be used in other activities within the DeFi ecosystem or exchanged for other cryptocurrencies on exchange platforms. Unlike traditional staking, where assets are locked for a fixed period and cannot be accessed until the staking process is complete, liquid staking allows users to access their tokens immediately after locking the assets. This provides flexibility and liquidity to investors, as they are not committed to keeping their assets locked for an extended period of time.

• Synthetic asset protocols: These protocols allow users to create and trade synthetic assets that represent other assets, such as fiat currencies, stocks or commodities. These synthetic assets track the price and performance of the underlying assets, allowing investors to gain exposure to different asset classes without directly owning the physical assets.

Audits and security

Security is a major concern in the DeFi ecosystem due to the decentralized and often experimental nature of the protocols. Security audits are a crucial process to ensure that a protocol is robust and resistant to vulnerabilities and attacks. During an audit, security experts review the protocol code for potential weaknesses and vulnerabilities. The presence of successful and transparent audits increases investor and user confidence in the protocol.

When evaluating a DeFi protocol, it is important to investigate whether it has undergone independent security audits conducted by recognized companies in the cybersecurity field. Audit reports should be publicly accessible and provide details on the findings and steps taken to address any issues found. A protocol that has passed audits and demonstrated a strong security posture is more trustworthy and less prone to attacks.

Here are some examples of the most reputable auditing companies.

• OpenZeppelin: OpenZeppelin is a leading security company in the blockchain industry. They have performed numerous security audits for popular DeFi protocols such as Compound, Aave and Uniswap.

• Trail of Bits: Trail of Bits is another well-known security firm that has conducted audits for prominent DeFi projects such as MakerDAO and Yearn Finance.

• Quantstamp: Quantstamp is known for its focus on smart contract auditing and has worked with projects such as Synthetix and Chainlink.

• CertiK: CertiK has performed audits for several DeFi protocols, including PancakeSwap and SushiSwap. They also offer formal verification services to ensure code security.

On the other hand, if you are a standard user and want to have some security measures to take on your own, here are some key measures:

• Use secure wallets: Use secure and trusted cryptocurrency wallets, such as hardware wallets which can be connected to MetaMask to grant them a higher degree of security.

• Verify URLs: Make sure you are interacting with official and verified websites through their social networks or pages such as Defillama. Avoid clicking on suspicious links or links received through unsolicited emails.

• Strong passwords: Use strong, unique passwords for your DeFi accounts. Using a combination of letters, numbers and special characters can make your passwords more secure.

• Enable two-factor authentication (2FA): Enable two-factor authentication on all your DeFi-related accounts that allow it. This adds an additional layer of security by requiring a second verification step in addition to the password.

• Do your research before investing: Before investing in a DeFi protocol, do your research on the project, its equipment and its security audits. Use reliable sources and verify information from several sources.

• Keep your devices secure: Make sure your devices are protected with antivirus software and regular updates. Avoid using public Wi-Fi networks for sensitive DeFi transactions.

• Do not disclose personal information: Never reveal your private passwords, recovery phrases or personal information online. Scammers may try to trick you into giving them access to your assets.

Community assessment and governance

Community and governance are key factors in determining the long-term viability of a DeFi protocol. An active, engaged and diverse community is indicative of sustained interest and potential growth. Participating in forums, social networking groups, and protocol-related discussions can provide insight into community perception and engagement.

Decentralized governance is another important consideration. It evaluates how decisions are made in the protocol and how token holders can influence updates and enhancements. Protocols that allow token holders to propose and vote on changes may be more flexible and adaptable as the DeFi space evolves.

To evaluate all of the above, you can also carry out certain practices of which we leave you with the ones we believe to be the most important.

Community:

-Participation in social networks: Look at activity on social networks such as Twitter, Reddit and cryptocurrency-specific forums. An active community often means there is genuine interest in the project.

-Number of members and followers: Check the number of followers and members on the project's official social media channels. A steady growth may indicate a growing interest.

-Comments and discussions: Analyzes comments and discussions in the community channels. Observe if there are constructive discussions, questions answered by the team and positive feedback.

-Development and collaboration: Investigate whether there are community contributions to the development of the protocol. The existence of collaborations and parallel projects may signal an active and diverse community.

Governance:

-Governance documentation: Read the protocol documentation related to governance. It should explain how decisions are made, how token holders can participate in voting, and how proposals are implemented.

-Decision history: Investigates the history of decisions made by the community through governance. Have major changes been effectively implemented in the past?

-Frequency of voting: Observe how often voting and governance decisions are made. Active and consistent governance suggests ongoing engagement.

-Participation in voting: If possible, check participation in previous votes. A high participation rate indicates that the community cares about the direction of the project.

-Actual influence: Investigates whether proposals submitted by the community have led to actual changes in the protocol. Effective governance translates into changes implemented based on votes.

-Transparency and communication: Evaluates whether the project team is transparent about governance decisions and implementation of changes. Open communication is crucial to maintain community trust.

Analysis tools

There are several tools with up-to-date data on all networks that can help you analyze and compare DeFi protocols:

-Tracking apps: Platforms such as Defillama, DeFi Pulse and DappRadar provide information on popular DeFi protocols, including their total blocked quantity (TVL) and user statistics.

-Project ratings: Websites such as CryptoSlate and CoinGecko provide detailed ratings and analysis on DeFi protocols, including security and community.

-Research platforms: Some research platforms, such as Messari and TokenInsight, offer deep analysis of DeFi protocols, going beyond the surface.

In conclusion, the choice of which DeFi protocol to invest in is a decision that should be made with caution and after thorough research. Evaluating the protocol's features, security, community, governance and using reliable analysis tools will help you make an informed decision and maximize your opportunities in the exciting world of decentralized finance.