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    Bankless

    Will DeFi Survive This?

    Wed Aug 02 2023
    DeFiCurve ProtocolExploitLending ProtocolsRisk ManagementSystemic Risks

    Description

    The episode covers the exploit of the Curve Protocol in DeFi, its implications and contagion, risks and challenges in lending protocols, Michael's financial situation and strategies, leverage and risk management, systemic risks, and provides a summary of insights. The exploit of the Curve Protocol resulted in the draining of Curve pools and a loss of $70 million worth of assets. The founder of Curve had a significant amount of CRV tokens as collateral, putting him at risk of liquidation. Lending protocols face risks due to market volatility and potential liquidation of collateralized assets. Michael's financial situation involves selling loans and collateralized assets to repay his debts. The use of leverage and socializing losses pose risks to lending and borrowing protocols. The episode concludes with insights on systemic risks, Lindy resetting events, code auditing, and the resilience of DeFi.

    Insights

    Exploit of Curve Protocol

    The exploit of the Curve Protocol resulted in the draining of pools and a loss of $70 million worth of assets. The founder's collateralized loans could lead to liquidation.

    Risks in Lending Protocols

    Lending protocols face risks due to market volatility and potential liquidation of collateralized assets. Borrowers like Michael are at risk of being liquidated.

    Michael's Financial Situation

    Michael sells loans and collateralized assets to repay his debts. He still owes $110 million against $290 million of curved tokens.

    Leverage and Risk Management

    Using excessive leverage can lead to precarious situations. Lending and borrowing protocols are increasing interest rates to mitigate potential bad debt.

    Systemic Risks

    There are systemic risks in DeFi, but they are not significant. Contagion seems focused on CRV token and lending/borrowing protocols.

    Insights on DeFi

    The episode provides insights on systemic contagion, code auditing, Lindy resetting events, and the resilience of DeFi.

    Chapters

    1. Exploit of Curve Protocol in DeFi
    2. Implications and Contagion of the Exploit
    3. Risks and Challenges in Lending Protocols
    4. Michael's Financial Situation and Strategies
    5. Leverage, Risk Management, and Systemic Risks
    6. Summary and Insights
    Summary
    Transcript

    Exploit of Curve Protocol in DeFi

    00:06 - 07:09

    • A coding language called Viper had an exploit that affected several DeFi protocols, including curve.
    • Curve pools were drained, putting pressure on the CRV token.
    • The founder of Curve had a significant amount of CRV tokens as collateral across lending protocols, potentially leading to cascading liquidations.
    • Approximately $70 million was stolen by the hacker, but $20 million was returned by a white hat and MEV bots.
    • The total value locked in curve decreased from 3.2 billion to 1.7 billion due to the exploit and people fleeing from it.
    • Curve is a systemically important protocol in DeFi and has been significantly impacted by this incident.

    Implications and Contagion of the Exploit

    06:44 - 20:12

    • Toku helps companies navigate the complex world of token compliance
    • Curve, a marketplace for like-kind assets, was exploited due to vulnerabilities in Viper-coded contracts
    • Several Curve pools were exploited, resulting in the loss of $70 million worth of assets
    • The attacker now holds 7.2 million Curve tokens
    • MEV bots captured some of the exploited funds during the process
    • Rocketpool stakers were awarded MEV fees from the exploited funds
    • Coffeebabe.eth returned $5.4 million of stolen funds
    • The ethical implications of receiving ill-gotten gains in a decentralized system like Rocketpool
    • MEV burn as a solution to socialize proceeds and prevent unethical MEV
    • Concerns about legislation making it illegal to benefit from unethical MEV
    • The contagion event surrounding CRV token liquidity
    • Flash crash of Curve token from 70 cents to 10 cents and back up to 60 cents
    • Draining liquidity and fear of getting dumped on in DeFi
    • Liquidity drained quickly from Terra Luna and curve tokens during a crisis
    • The curve exploit holds 8% of the circulating supply of CRV, which is about seven million tokens
    • The hacker can market dump the tokens and liquidity providers stop providing liquidity, causing liquidity to dry up
    • There is a potential for a bad event in curved tokens due to the current setup
    • The hacker's wallet contains $14 million worth of ether along with the curve tokens
    • We are witnessing a bank heist play out in real time on the internet, with every transaction being tracked on-chain
    • People are closely watching the state of CRV as it is one button press away from being nuked to zero
    • Curve founder Michael owns 48% of the circulating supply and has been borrowing against it with lending and borrowing protocols
    • Michael has deposited his curve tokens as collateral in various lending protocols, totaling millions of dollars
    • This puts Michael in a precarious position as his collateralized loans could lead to liquidation

    Risks and Challenges in Lending Protocols

    26:13 - 32:36

    • Lending protocols allow users to deposit assets and receive stablecoins in return.
    • Stablecoins obtained from lending protocols are often used for speculative purposes rather than responsible actions like earning interest.
    • The value of Ether can drop significantly, leading to potential liquidation of collateralized assets.
    • Crypto market volatility can result in risky situations for borrowers.
    • When a lending protocol experiences stablecoin withdrawals, interest rates increase due to insufficient supply.
    • At 100% utilization, the interest rate for borrowing Tether from Aave doubles every 12 hours.
    • Michael, the founder mentioned in the podcast, is at risk of being liquidated due to increasing interest rates and dropping prices.
    • To avoid liquidation, Michael needs to continue paying interest and sell his collateralized assets to repay his loan.

    Michael's Financial Situation and Strategies

    32:27 - 39:02

    • Michael sells some of his loans and receives about $16 million.
    • Buyers are stepping in and buying curve tokens.
    • There is speculation that the OTC trades for a large amount of curve tokens were sold at around 40 cents per token.
    • Michael raises $16 million but still owes $110 million against $290 million of curved tokens.
    • Defending your liquidation price on chain is a religious experience.
    • Michael expressed surprise that he hasn't been affected by DFI hack yet.
    • Michael owns two mega mansions in Melbourne, Australia.
    • It is unclear if Michael used stablecoins borrowed against his curve to buy the mansion.
    • One reason for borrowing against curve tokens instead of selling them is to avoid liquidity issues and capital gains taxes.

    Leverage, Risk Management, and Systemic Risks

    38:37 - 45:27

    • Using leverage to avoid capital gains taxes is a common strategy among wealthy individuals.
    • Michael's situation serves as a cautionary tale against using excessive leverage.
    • Leverage can be a useful tool, but it requires careful consideration and risk management.
    • There may be an incentive mismatch in lending and borrowing protocols, where founders can socialize their losses to the protocol.
    • Lending protocols are increasing interest rates for borrowers like Michael to mitigate potential bad debt.
    • Gauntlet had previously warned about the risk parameters of certain assets, but Aave governance rejected their proposal.
    • Assessing the risk of assets in lending and borrowing protocols is challenging and carries potential costs for the protocol and token holders.
    • The podcast will further discuss the protocol game of chicken, systemic risks in DeFi, and lessons learned from this event.

    Summary and Insights

    45:06 - 1:02:10

    • MetaMask has introduced a new feature called MetaMask Portfolio, which provides a holistic view of your crypto portfolio across multiple chains and addresses.
    • Mantle is the first DOW-led Web3 ecosystem built on top of Mantle Network, a high-performance Ethereum layer 2 that reduces gas fees by 80%.
    • Arbitrum provides secure Ethereum scaling solutions with faster transaction speeds and lower gas fees.
    • Systemic contagion in crypto can be caused by a low number of people. For example, Three Arrows Capital's liquidation affected lenders who had borrowed money from them.
    • Michael spread out the contagion by collateralizing Curve in various DeFi platforms.
    • Aave has an insurance fund called the Ave Safety module with $327 million to cover any potential losses caused by Michael's actions. However, it is denominated in Aave tokens which could affect its value if sold to cover losses.
    • Using a protocol's own token as defense against losses can be precarious due to potential token holder haircuts and price impacts.
    • Chinese protocols are jacking up interest rates to avoid holding the bag
    • Protocols like Magic, Internet Money, MIM, Inverse Finance, Silo Dow, and Aave are dealing with this problem
    • There is a race condition where raising interest rates increases the likelihood of Michael getting liquidated
    • There is systemic risk to DeFi but it's not that big
    • Contagion seems focused on CRV token and lending/borrowing protocols
    • Governance proposals from gauntlet or large holders are being scrutinized more carefully
    • The current positions Michael has and the liquidation prices for Ave, Frax, and Abra Kadabra
    • 37 cents is the liquidation price curve must stay above to prevent cascading liquidation
    • Michael might be able to raise more capital off-chain to pay down loans
    • Rune Christensen sees this as a cycle and believes it could be the last crash before a stronger bull market
    • Curve had a lot of Lindy (longevity) in terms of TVL
    • The White House is on its second iteration, having burned down once before.
    • Curve Finance experienced a Lindy resetting event, which is the longest in DeFi's history.
    • The issue with Viper, an EVM compiler level problem, highlights the importance of vetting and auditing code.
    • Solidity has a stronger Lindy than Viper due to being an older language with more assets dependent on it.
    • Crypto is inherently risky, and there may be other undiscovered bugs in the codebase.
    • The underfunding of public infrastructure like Viper poses a risk to the entire crypto ecosystem.
    • DeFi protocols performed as expected without socializing losses or bailouts.
    • Despite the risks, surviving challenges makes DeFi stronger.
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