Learn about vulnerabilities in blockchain smart contracts, wallets, and high-frequency trading. Find out how to optimize your Web3 security.

Web3 Security: Challenges and Strategies You Need to Know

Are classic security strategies sufficient to meet the new challenges of decentralized finance? The rise of Web3, with its transformative potential in DeFi and NFTs, has opened a new frontier in the digital economy, creating a more accessible and transparent financial ecosystem. However, this progress has also exposed a multitude of hidden vulnerabilities.


The global market for decentralized finance is expected to exceed $200 billion by 2030. But with this potential comes a harsh reality: in 2022 alone, smart contract vulnerabilities accounted for 27% of all blockchain security incidents, resulting in losses exceeding $1.7 billion.


Unlike traditional finance, Web3 is based on blockchain technology, introducing new attack vectors. Smart contracts are a prime target. As a result, organizations face a critical challenge: how to capitalize on the exciting opportunities of Web3 while ensuring the robust security of their operations.


In this blog post, we'll examine the security challenges posed by Web3, focusing on vulnerabilities in smart contracts, custodial wallets, and high-frequency trading systems. We’ll also discuss how you can optimize your Web3 security posture and harden your operations against these emerging threats. 


Web3 security issues


While Web3 offers a wide range of financial solutions, its decentralized nature presents unique security challenges that differ significantly from traditional FinTech security concerns. This section explores three critical areas where vulnerabilities can compromise the integrity of your Web3 operations:


1. Smart contracts vulnerabilities


Smart contracts are self-executing programs with the terms of the agreement written directly into the code. While they offer automation and transparency, they also present several risks. These are the ten most common vulnerabilities identified by the OWASP Top 10:


1. Reentrancy attacks: These allow attackers to steal funds or manipulate contract status.


2. Integer overflow and underflow: Errors in the handling of integer values can lead to unexpected behavior. Attackers can use these errors to manipulate contract states or steal funds.


3. Timestamp dependence: Malicious actors can manipulate system time (e.g., through blockchain forks) to exploit time-based features within the contract.


4. Access control vulnerabilities: Inadequate access control mechanisms may allow unauthorized users to perform restricted actions on the smart contract, which could lead to asset theft or manipulation.


5. Front-running attacks: By tracking pending transactions, attackers can place their own transactions ahead of yours and manipulate the outcome in their favor (e.g., buying an NFT ahead of you at a lower price).


6. Denial of Service (DoS) attacks: Attackers can overwhelm a smart contract with a large volume of transactions, hindering its functionality and preventing legitimate users from interacting with it.


7. Logic errors: Errors in the logic or design of the smart contract can lead to unintended consequences. These errors can be difficult to detect and have a significant impact on the functionality of the contract.


8. Insecure randomness: Using predictable sources of randomness in smart contracts can compromise their security. Attackers could exploit this predictability to manipulate outcomes in their favor (e.g., gambling).


9. Gas limit vulnerabilities: Gas, the unit of computation in a blockchain, is necessary to perform smart contract functions. Setting an insufficient gas limit can lead to transaction failures and potential loss of funds.


10. Unchecked external calls: Smart contracts often interact with other external contracts. Failure to properly validate or sanitize the data received from these external calls can expose the contract to vulnerabilities in the external code.


2. Custodial wallet security issues


Custodial wallets provide an easy-to-use experience for digital asset management. However, their centralized nature presents unique security challenges that require careful consideration. Here are some of the key security issues associated with custodial wallets:


1. Single point of failure: Because custodial wallets store users' private keys, a security breach or technical malfunction could create a single point of failure that could result in significant financial loss for users.


2. Counterparty risk: Users entrust their digital assets to the custodial. If a custodial experiences bankruptcy or insolvency, users' funds could be at risk. Unlike traditional banks, which are protected by deposit insurance, there is no guaranteed protection for funds deposited in custodial wallets.


3. Limited transparency: Custodial wallets may offer less transparency into how users' funds are stored and insured. This lack of transparency may concern users who value control and visibility over their assets.


3. Challenges of High-Frequency Trading (HFT)


High-frequency trading (HFT) in the context of Web3, especially in DeFi, presents its challenges:


1. Front-running attacks: Attackers can pre-empt pending transactions to profit from the price difference. They use bots to monitor the network and execute trades before the original trade is confirmed.


2. Network congestion: A high volume of transactions can congest the network, resulting in long wait times and higher transaction costs (gas fees). Attackers can exploit Denial of Service (DoS) attacks.


3. Code security: Because many DeFi applications are open source, attackers can examine the code for vulnerabilities they can exploit during periods of high activity.


Strategies for strengthening security in Web3


Now that we have identified the major security issues in Web3, we will explore strategies and best practices to mitigate these risks:


1. Smart contract security


● Rigorous smart contract audits: Investing in thorough smart contract audits performed by experienced security professionals is critical. These audits meticulously analyze your code for potential vulnerabilities, ensuring it adheres to best practices and minimizing the risk of exploits.


● Formal verification: Formal verification, a powerful technique involving mathematical proofs, can be used to ensure that smart contract code works as intended and to eliminate potential bugs.


● Open-source libraries with a proven track record: When using libraries in your smart contracts, prioritize open-source, well-established libraries with a proven track record of security and regular maintenance.


2. Custodial wallet security


● Periodic penetration testing and vulnerability assessments: Performing periodic pen-testing and vulnerability assessments of your custodial wallet infrastructure helps identify and address security vulnerabilities before they can be exploited.


● Multi-party computing (MPC): Implementing MPC technology can enhance the security of custodial wallets by distributing private key management across multiple servers. This makes it much more difficult for attackers to access user funds.


● Hardware Security Modules (HSM): Using HSM provides an additional layer of protection for the private keys used by custodial wallets. HSMs are tamper-resistant devices designed to securely store keys and perform cryptographic operations.


● Strong access controls and monitoring: Implements robust access controls with multi-factor authentication and user activity monitoring to detect and prevent unauthorized access attempts.


3. HFT attack mitigation


● Transaction validation and price limiting: Implement robust transaction validation mechanisms to ensure data integrity and prevent tampering. In addition, consider rate-limiting measures to mitigate denial of service attacks.


● Stress testing and backtesting: Perform periodic stress testing to identify potential bottlenecks and vulnerabilities under high-transaction volume conditions. Backtesting historical data from your systems can also be valuable in uncovering potential security risks.


● Secure coding and code review: Apply secure coding practices to your development teams and implement thorough code review processes to eliminate potential vulnerabilities in your systems.


Take control of your Web3 security future


Web3 represents a dynamic world of opportunity, but navigating its complexities requires a proactive security posture. 


At Acid Labs, we bridge the gap between traditional security expertise and the modern Web3 landscape. We have certifications in cybersecurity, such as ISO 27001, and deep experience in fintech and e-commerce. This unique combination of expertise in classic and emerging technologies allows us to help you mature your business and adopt new practices with confidence. 


Our comprehensive Operations Audit and Optimization solution for Web3 includes:


● Smart contracts: We perform static and dynamic analysis of your smart contracts. Dynamic analysis involves running the contracts in an isolated environment to detect common vulnerabilities, such as unauthorized issuance of new tokens or unauthorized withdrawal of funds. Static analysis, on the other hand, consists of a line-by-line review of the code to ensure its robustness and detect potential security flaws.


● Blockchain: We create customized development environments (TestNet, Test Network) for enterprises to deploy and test their decentralized applications (DApps) securely and efficiently. We optimize validator nodes to improve performance and provide developers with cost-effective test environments with optimized response times to ensure their DApps work optimally.


● Custodial wallets: We perform penetration testing in all modalities (Black Box, Gray Box, and White Box) and deliver detailed reports on the results. These tests allow us to identify and correct vulnerabilities in the custodial wallets, thus protecting users' assets from potential attacks.


● High-frequency transactions: We offer a combination of microservices that connect to the APIs of exchanges such as Binance, HTX, BitFinex, and others to process information in real-time. This solution is ideal for businesses that rely on real-time transaction data, such as trading and analytics, to ensure that transactions are executed in a timely and accurate manner.


Ready to optimize your Web3 security posture? Contact us today to learn how our solutions can help you protect and optimize your business.

Publication date: May 24, 2024.

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Optimize your Web3 security