The Complete Guide to Smart Contract Auditing - Benefits and Risks
Decentralized finance (DeFi) offers lucrative opportunities somewhat unavailable in the traditional centralized system. In this blockchain-based environment, almost anyone can use smart contracts to launch financial applications without a central authority's approval. Moreover, others can use these applications to generate and build wealth with little to no trading experience.
Unfortunately, these ventures pose considerable risks for everyone involved, especially when the applications run on faulty smart contract codes. Security issues and system breaches have seen projects lose $4,25 billion to hackers in 2021. A year before, the DeFi space lost $1,49 billion to heists, scams, and rug pulls.
These figures represent an era of crypto projects launching en masse without auditing their smart contracts. Recently, developers and users are acknowledging the importance of eliminating all the bugs and loopholes in a smart contract code before entering the market.
This guide to smart contract auditing looks closely at a professional service that makes the DeFi space safer for everyone.
A smart contract audit is an advanced testing procedure of an application’s smart contract code.
The process consists of using manual and automatic bug detection tools to identify the flaws and vulnerabilities in the code. Generally, a professional smart contract auditor performs this procedure and reports the findings to the project's developers.
The auditing process also includes executing the protocol's code review, which the auditors perform manually. The developers use this report to repair the code and remove the bugs. Next, the smart contract undergoes another audit. The process repeats until the code is flawless and the auditors release a final report and a successful audit certificate.
A project passing a smart contract audit is highly likely to launch successfully. Moreover, it commands increased trust and reliability from users and investors. Above all, it has a minimal risk of succumbing to heists and hack attacks due to loopholes in its smart contract code.
How Smart Contract Auditing Works?
The primary purpose of auditing a smart contract is to determine its security against various exploitative attacks. To this end, the developers must provide the auditors with the project's specifications, code information, and overall architecture.
The auditors use this data when threat modeling the testing process and performing manual and automated tests on the smart contract code. For example, they test how the code will respond to denial-of-service attacks - a common hacker’s attempt to render the protocol’s resources unavailable to its users.
The auditing process exploits all the vulnerabilities encountered in the first testing phase. Next, the auditors give the developers a first audit report containing the errors they found, their feedback, and potential solutions.
After the development team fixes the flaws and vulnerabilities, the auditors restart the testing procedure. Again, they gauge the project's susceptibility to threats and compile a new report. This process repeats until the smart contract’s code is 100% bug-free. Lastly, the entire auditing process differs between projects depending on code complexity.
The Risks of Not Using Smart Contract Auditing
A professional smart contract audit enhances a project’s protection against hackers. It also reduces the risk of costly smart contract code flaws while increasing investors’ trust in the protocol. Nevertheless, some projects prefer launching without undergoing an audit. That is how they expose themselves to considerable security risks, such as the ones below.
One of the most common attacks on non-audited crypto projects is the rug pull. This technique has seen scammers make way with over $2 billion in 2021 alone. Industry experts advise users and investors to DYOR (do your own research) and avoid boarding projects that have not passed security risks.
A rug pull occurs when developers or users manipulate a token's value to make it more lucrative than its potential. After onboarding several investors, they abandon the project and disappear with their capital. In other words, they pull the rug from under their beneficiaries.
Generally, rug-pulling scams target novice investors. They consist of rushed projects with ambiguous mechanisms and vague roadmaps. However, some hackers make the necessary effort to make their projects more credible. Also, they tend to resemble other, more successful cryptocurrencies in the market.
These projects have one thing in common. They either did not pass smart contract audits or did so with obscure, non-professional auditors.
One of the most common rug pulls is disabling the ability to sell tokens for users and investors. The developer adds to the smart contract's code after its launch to prevent token holders from selling their assets. As a result, the market activity shows only an increase in buying said token, forcing its price to surge. The developer then sells his tokens at a high price leaving the investors with worthless assets they cannot sell.
Developers Cashing Out
This scam occurs when a scammer launches a project with an overstated value proposition. Generally, this venture promotes a token or a platform still in development. The malicious developer overhypes the project, betting on the investors’ FOMO (fear of missing out). In return, he attracts substantial capital before even launching the product.
In reality, the scammer only mints an insignificant token while keeping most of the token supply for himself. After the token’s value skyrockets, the developer sells his assets, cashing out all his shares in the project. This move could happen overnight or over a long period to make the rug pull less obvious. Nevertheless, the result is the same. Once the scammer sells all his tokens, the other investors are left with a worthless asset.
The term “Liquidity" stands for a crypto asset’s ability to turn into real money. Increased liquidity is usually a trait of high-value cryptocurrencies. Furthermore, liquidity enables investors to buy or sell orders rapidly. So, liquidity providers (LPs) are crucial for DeFi products relying on high liquidity.
These projects use liquidity locking, which consists of a pool that investors fund with another cryptocurrency. In return, they can buy and sell the projects' tokens. Locked liquidity remains there for a specific period during which the providers cannot use it. After that period, the users can unlock their funds and receive a reward for their support.
Scammers have developed "liquidity stealing" - a rug pull difficult to spot even by expert investors. In this scam, the developers create an apparent legitimate token and invite investors to fund its pools with more popular cryptocurrencies. After the pools amass a considerable amount of crypto, they retrieve valuable assets from the pool, leaving only the tokens they created, which are now worthless. Unfortunately, investors cannot regain their liquidity and often lose substantial capital in this case.
Crypto Liquidity Locks - How to Avoid Liquidity Stealing
Some projects use time-locked smart contracts to lock liquidity for specific periods. This implies the LPs automatically receive their funds back on the selected unlocking date. So, a genuine project will maintain an impenetrable time lock on the funds, making them impossible to be moved, spent, or rug pulled.Locking liquidity brings enhanced security, reducing the risk for most scams and rug pulls. It also increases the project’s credibility with exact terms on how the LPs can provide and retrieve funds. Lastly, it helps new tokens rise in value rapidly and offer lucrative opportunities for early adopters.
Nevertheless, crypto liquidity locking is not entirely safe, and this practice has downsides. For example, the value of the locked assets could diminish before the automatic unlock. This may happen for a variety of reasons, including market crashes.
Additionally, the risk of liquidity stealing looms over any projects with a non-audited smart contract. Regardless of its pool size or flawless history in the market, a project that has not passed security checks can always turn out to be a scam. Generally, professional smart contract auditing services expose these projects or help them improve.
Before locking liquidity in a project, users should research it and ensure it has a smart contract audit report from a reputable auditor. Next, they should consider the length of the lock. For example, time locks are lucrative if they surpass one year. Generally, a three-year or five-year lock could be even more profitable.
The Benefits of Smart Contract Auditing
Increasingly more crypto projects opt for smart contract auditing before launching. Furthermore, they have several options of auditors to choose from, including professional and non-professional services.
Employing a non-professional auditor may involve lower costs and faster turnaround times. However, it also increases the risk of obtaining a superficial smart contract audit. As a result, these projects may not identify the vulnerabilities in their codes before launching. Moreover, they will pay a heftier price later when a successful heist speculates those flaws.
Conversely, using professional smart contract auditors like Solidproof, minimizes the risk of attacks on a project. These services extensively test a smart contract's code using advanced automatic and manual tools. Most importantly, they identify and help solve code vulnerabilities before they become potential security breaches.
Professional auditing services help bring safer DeFi products on the market. They enhance the projects’ credibility and the investors’ trust in the entire industry. Above all, they reduce heist and hacker activity in an increasingly competitive sector.
Never put your DeFi security down! Besides the golden rules above, you should remember that there is hardly a comprehensive list to cover all potential vulnerabilities. The more blockchain and DeFi grow, the more sophisticated attempts hackers create to exploit the systems and steal your money.