đThe exploit that shook DeFi
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GM friends.
Hereâs what Iâll cover today:
đWhat we know about the rsETH exploit
đ Crypto chart of the week
đď¸ The latest DeFi news
đ What we know about the rsETH exploit
Kelp DAO suffered one of the largest DeFi exploits in a long time last week.
116,500 rsETH (worth ~$290M) were minted out of thin air by a hacker who exploited KelpDAOâs rsETH bridge powered by LayerZero via a forged cross-chain message.
While this alone is a terrible event, the fact that rsETH was deeply integrated into DeFi made things much worse.
For example, it was supported as collateral on Aave.
Once the hacker minted the rsETH tokens, he immediately used them to borrow ETH against them on Aave, leaving Aave with over one hundred million dollars in bad debt.
And Aave is not the only protocol affected by this exploit.
Compound, Lidoâs EarnETH vault, some Morpho lenders, Hyperithm's mHyperETH product, Superform's SuperWETH vault, and many other protocols were also impacted as they had some exposure to rsETH in one way or another.
Whose fault is it here?
This situation is a bit more nuanced than in other exploits like Drift.
Because the hacker exploited Kelp DAOâs rsETH bridge, which was powered by LayerZero, rather than Kelp DAOâs own smart contracts.
And no one seems to want to take responsibility. LayerZero is blaming Kelp DAO, and Kelp DAO says that it is the fault of LayerZero.
Now, if we look at this situation objectively, here are some facts:
For this attack, the hacker compromised two of the RPC providers that LayerZero DVN was using in order to be able to mint rsETH
Kelp DAO was running only a 1/1 DVN (multisig) setup for its rsETH bridge (meaning that there was a single verifier that had to approve a fake transaction as real for the exploit to succeed)
LayerZero blames Kelp DAO for using a 1/1 DVN configuration, but at the same time, LayerZero is the one who allowed dApps to use a 1/1 DVN in the first place
47% of the dApps leveraging LayerZeroâs bridge infrastructure used a 1/1 DVN before the hack, so Kelp DAO was not the only one
So, without getting into too many technical details, to me it seems obvious that LayerZero deserves most of the blame and should recognize their mistakes.
Indeed, the fault of Kelp was that it used a single verifier ( 1/1 DVN) for its rsETH bridge. Using multiple verifiers could have prevented this exploit.
But this hack wouldnât have been possible if the RPC nodes hosted by LayerZero hadnât been compromised in the first place.
Whatâs next?
Fortunately, almost a third of the funds stolen by the hacker had already been recovered by Arbitrum, which announced it had frozen the hacker's funds.
This doesnât look great from a decentralization perspective.
But I think it is better to do this and protect users, given that it is possible, than pretend that L2s are fully decentralized when in reality they arenât.
Meanwhile, Aave is considering multiple solutions to cover the bad debt it incurred.
LlamaRisk, Aaveâs risk manager, outlined two potential scenarios:
Uniform socialization of losses across all chains where Aave is deployed, with ETH lenders on Ethereum mainnet being left with a 1.54% loss
Isolate losses to the L2s where rsETH was used as collateral by the hacker to borrow WTH, with ETH lenders on Mantle being left with a 71% loss
These numbers were mentioned before Arbitrum froze 30,766 ETH held by the hacker, so the loss will likely be smaller.
Thereâs a chance that Aave uses its treasury to cover a part of the bad debt. Mantle also confirmed itâs working on a recovery plan.
My hope is that the final resolution will include no losses or very small losses for Aave users. Aave has long been perceived as the best DeFi app for low-risk yield, and this incident, unfortunately, significantly damaged its reputation.
Lastly, Iâve seen many people say that DeFi is dead because of this exploit that affected so many tier-1 protocols.
I donât agree with this, as this industry has faced many setbacks over the past years and has always managed to make a comeback in one way or another.
DeFi will be fine, but thereâs a lot of work to be done to make it secure first.
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Chart of the week
Crypto cards are gaining massive traction
Crypto meme of the weekđ
The latest developments in DeFi
Polymarket announced the launch of its own perps DEX
Jupiter Lend enabled borrowing against tokenized stocks
Pendle airdropped ~$7.5M in CHIP tokens to sPENDLE holders
Alchemix launched Alchemix V3 - a new DeFi lending primitive
Base announced Base Azul - a network upgrade that will enable it to process up to 5,000 TPS and increase decentralization
Drift announced a hack recovery pool with up to $147.5M from Tether and other partners. The package includes a revenue-linked credit facility
Catalysis, a DeFi insurance vault protocol powered by EigenCloud, went live
USDai, a GPU-backed stablecoin protocol, launched its token CHIP
Kelp DAOâs rsETH was unfortunately exploited for $290M
Arbitrum froze 30,766 ETH held by the rsETH exploiter
Optimism announced stake-based transaction ordering - a feature that enables users to get their transactions processed faster by staking OP
Hit One, a gamified dApp offering 1000x leverage, went live on MegaETH
Brix is launching wiTRY, the first Turkish Lira stablecoin with 37% APY, today
Extended implemented daily withdrawal caps to protect itself against exploits
Avici released Avici Grow and Smart Credit, enabling users of its on-chain neobank to take loans and earn yield via Fluid
Drift hack victims sued Circle for refusing to freeze stolen USDC funds
Thatâs all for this week!
Until next time,
The DeFi Investor
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