$15 billion out, 100% utilization, weak backstop – What broke inside Aave?

AMBCrypto reported that rising blockchain exploits caused the DeFi sector to suffer losses in excess of $620mn. reported.

Aave is a leading DeFi lender took a direct hit KelpDAO is a Kelp-based exploit.

As a result, the rsETH protocol is exposed. Attackers created 116.5K of unbacked rsETH to use as collateral for high-quality assets.

Aave had to deal with bad loans totaling over $200 million, leading to a sudden outflow of capital.

Why did Aave Liquidity collapse so rapidly?

Aave markets were quickly impacted by the exploit, which led to a rapid tightening of liquidity.

Users began to withdraw funds within hours and the utilization rate reached extremes. The WETH reserve pool was 100% utilized, and there is no immediate liquidity left in the pool.

The protocol was affected by the shift.

Aave’s platform saw deposits fall from $45.6 to $29.2 Billion, a drop of approximately $16.4 billion.

As a result, the Total Value Locked on the platform increased. [TVL] 15 billion dollars, the last time we saw this level was in November 2024. 

In addition, AAVE stablecoins have been used less by 54.2%. From $15.95 to $7.31. The amount of stablecoins that were borrowed also decreased 37.9%, from $10.60 billion to $6.63billion. 

Sparklend was a refuge for investors and participants in the market, while AAVE saw a rise in outflows. 

Sparklend’s TVL increased from $1.9 billion up to $3.5 billion. This represents a $1.3-billion gain. Sparklend, in the midst of this crisis has taken a significant amount of funds. Aave [AAVE]It is especially important to hear from larger entities. 

What happened inside Aave actually?

This exploit revealed how Aave’s liquidity is heavily linked to looping strategy. The looping strategies were based on depositing ETH-based rsETH as well borrowing. Ethereum [ETH] Increase the yield.

Blockworks Thread Data showed The ETH LSTs accounted for 98.5% (or a total of $1.25 billion) of the collateral used to back WETH loans.

It was still a concentrated structure of risk, not a diverse lending book. This structure collapsed very quickly when the exploit was discovered.

Depositors who did not have a direct relationship with rsETH, but whose funds backed up those positions still suffered because of their losses. This shift revealed a major imbalance.

Aave treats all lenders the same, even if their risk levels are different. The depositors were not compensated for the higher level of risk.

Aave’s safety net can it absorb damage?

Aave Umbrella underwent its very first test of stress when the liquidity ran out. Umbrella is designed to recover bad debts using junior capital staked.

The extent of coverage was limited in comparison to potential losses.

The backstop may only cover a portion of the loss, with the remainder falling to the DAO and/or the depositors.

Increasing utilization and liquidity shortages also weakened the liquidation mechanism, which slowed recovery. The markets were in a hold pattern as participants waited to see if there was clarity.

Final Summary

• Aave took on over $200M worth of bad debt after hackers minted 116.5K non-backed rsETH, and then drained the liquidity via leveraged lending.
• Sparklend, a safer protocol that has gained more than $1.3B in capital as investors prioritised liquidity and risk controls.