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Back to today's story. 👇
We've been hack-free for a bit, haven't we?
Sadly it didn’t last long. 😥
On Sunday, Curve Finance dropped some shocking news: they'd been hacked. 😨
Picture Curve as a virtual bank 🏦. They hit a snag due to issues with the programming language they used (Vyper).
This problem led to an attack similar to someone tricking a bank system.🎭
The attack, known as a "re-entrancy" attack, is like a game of phone tag 📞 - imagine if person A calls person B, but before person A can finish their sentence, person B calls back.
This creates confusion, right? 🥴
This mix-up in the world of smart contracts (code-based agreements) enables the attacker to dupe the system, making it seem there's more cash than there is, facilitating a theft! 💰
It's not a Curve-exclusive issue – other protocols were hit too – but we're focusing on them today due to their size.
The amount stolen remains uncertain, with sources citing different figures. But whatever the amount, it's nothing Curve can't handle. 👍
The real issue lies in the potential ramifications of this exploit. 🌩️
Main worry: Curve's founder, Michael Egorov, staked a massive 300M Curve (34% of all CRV supply) as collateral for a loan on Aave.
With the CRV price nosediving, Egorov's loan could be at risk of liquidation, which could lead the DeFi industry into a black swan event.
Let’s explore. 👇
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Curve's chief, Michael Egorov, used his own CRV as collateral to borrow more than $100M in stablecoins across several DeFi lending protocols. 💸
On Aave alone, he locked 300M CRV and borrowed 60M USDT, with the liquidation price of 0.3767 CRV/USDT.
300M CRV represents around 34% of the entire CRV supply. 😲
All of which could be dumped into the markets if the price of CRV drops ~33%. (At the time of this writing, CRV is $0.60).
Update: Egorov paid off some of his loan, so the liquidation price is now lower.
Context: Liquidation means that all of Michael’s collateral is dumped on the market, in case the CRV price hits ~$0.37. 💣
If that happens, it would cause a huge market dump, causing even more liquidations. 😨
And since there are no willing buyers right now, tokens would be dumped into the market, with no one to buy them.
But let’s go back for a second… Why would Curve’s CEO take a loan in the first place, if he had so much CRV he could sell? 🤔
Instead of offloading a ton of CRV (which would've caused a price crash), he chose to stake it as collateral in platforms like Aave, borrowing 60M USDT in return.
Had he sold $60M worth of CRV directly, there'd be a community uproar! 😱 Thus, many big players borrow tokens, rather than sell, to avoid market impacts.
But that’s not all! Meet the concept of Loan Utilization Rate. 🤝
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Example: If you deposit 100 ETH into a platform, to borrow 70 ETH, that means you’re utilizing 70% of your loan. 📊
The higher the utilization rate, the higher your interest rate is on the loan you took.
If your collateral (100 ETH in this example) dips in value, your utilization rate climbs. 📈
Hit a 100% rate and your interest doubles every 12h, soaring up to a mind-blowing 10,000%! That's your debt doubling in just hours. ⏰
This is HUGE to grasp. Why? Egorov started with ~4% interest. If he stuck with a 100% utilization rate for 3.5 days, his rate would've hit 10,000%! 🤯
To dodge this, Egorov started offloading CRV tokens to other players in crypto. He raked in millions of $$ by selling ~18M CRV, according to The Block:
Tron founder Justin Sun bought 5 million CRV 🌞
Crypto trader DCFGod snapped up 4.25 million CRV 🎩
NFT owner Jeffrey Huang — known as Machi Big Brother — bought 3.75 million CRV 🖼️
Crypto investors DWF Labs picked up 2.5 million CRV 💼
DeFi project Cream Finance purchased 2.5 million CRV 🍦
Thanks to this wider crypto community support, his utilization rate fluctuated and dropped. 📉
But why does it matter if Egorov gets liquidated? Why is everyone caring about this loan?
Short answer: Because it could trigger a domino effect on the entire industry.
Egorov's liquidation wouldn't just be his headache, it could've caused a real upset in the entire DeFi ecosystem! 😬 Here's why: low liquidity and bad debt.
In DeFi, when someone wants to exit a loan or pool, another side must cover it. There must be liquidity on both sides of the table.
But when everyone looks to exit the market due to concerns, liquidity disappears. This is what’s happening with Curve.
So… If the market is going to liquidate Egorov’s 300M collateral once CRV hits $0.37, how will it do it if there’s no liquidity on the market? 🤷
Answer: It can't. At the moment, liquidity is not there.
No liquidity to liquidate means the protocol is left holding the bad debt bag.
Bad debt is when a wallet ends up owing more than the collateral it has.
It's like you owing $320, but only having $75 worth of assets. That's a debt that'll likely never get repaid - bad debt.
In Egorov's scenario, if CRV touched $0.37, the 300M Curve stuck in Aave would turn into bad debt. Aave would then have to foot this bill. 💸
Fortunately, even if this happens, Aave has a $330M safety fund. So they’re prepared to cover this if needed.
But if this loan gets liquidated, it would spiral out of control and the consequences would be huge, potentially leading to a black swan event in DeFi. Keep reading. ⏬
Could we be on the brink of a DeFi Black Swan event? While it's worrisome, let's clear up some things.
First of all, the situation seems to be better than it was on Tuesday, thanks to many crypto participants mobilizing and helping Curve raise money.
Egorov managed to pay off some of his debt. His liquidation price is lower and so is his utilization rate.
Second of all, even if Aave had to cover Egorov's bad debt, they'd manage, which is relieving. 😌
With that said, we are witnessing a mass withdrawal. Curve's Total Value Locked (TVL) halved from $3.2B to $1.6B. 📉
And in (the worst) case that Ergov’s initial loan gets liquidated on Aave, other liquidations will follow suit and it’s going to cause a big market dump.
If that happens, we could see many DeFi projects die in the next few months. ❄️
However, as Rune Christensen, CEO of MakerDAO, rightly points out, this is far from the end of DeFi.
If a black swan event takes place, it’ll most likely set the industry back by months or even years. 🫠
It would certainly scare away tradfi investors who are now considering dipping their toes into DeFi.
But that’s okay. Because we have some key takeaways from what happened this week. 👇
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Enjoy...
The main takeaway from all of this is that there are no special rules or bailouts in DeFi, no matter who you are. It’s a brutal free market governed by math and code. 👨🔬
And even if this looks like a crisis, the smartest people will understand that the 'no special rules' feature is DeFi's main strength. 💪
As you’re reading this, you’re in the top 1% of people who understand the future and are ready to capitalize on the next big phase of the internet. 🌊
To ensure you do so successfully, you need to understand 1 thing: BEWARE OF LEVERAGE!
There's no free lunch in crypto. Even veterans sometimes fall into the leverage trap.
So before aping into any DeFi plays, ask yourself:
Is my ETH or BTC worth risking for a 5% APY? 🤔
Then remember… By merely investing in ETH and BTC, you're signing up for a yearly average return of 150%.
That's something that you rarely get in traditional finance!
Why risk it all for an extra yield or loan? Not worth it unless you're all-in on DeFi.
Your best bet: DCA and HODL your Bitcoin and Ethereum! 🤲💎
Now... Are we saying you should exit DeFi all together? Definitely not.
But it's important that you weigh your risks and make a decision based on how your portfolio is structured.
If you're all-in on DeFi, you may want to rebalance that by exisiting some of your positions.
Where there's smoke, there's usually fire. And DeFi's smoking right now. You don't want the flames to catch you.
On the flipside, if you're in DeFi with a merely a small percentage of your portfolio, then you're most likely fine. But treat that position as 'gambling money' because you could lose it all.
Lastly, let's remember than in times of crisis (when everyone is exaggerating, like now) is usually the worst time to fade an industry.
We may well be at the bottom of the bad news and therefore, leaving the DeFi industry at these times would be a mistake.
So keep watching this space, rebalance your portfolio accordingly so you don't get rekt in case things take a nasty turn, and, most importantly, don't get caught up in the hype cycle. 🚨
That's it from us, friends! If you enjoyed today's breakdown make sure to collect this post. (it's free). And you never know what collecting this might do for you in the near future. 👀
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Thanks for reading. And remember, you're strong, you’re powerful, you’re alpha! ❤️
See you soon. ✌️
Disclaimer: This article is for informational purposes only and not financial advice. Conduct your own research and consult a financial advisor before making investment decisions or taking any action based on the content.
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1,169
Great post!!! I did enjoyed it. I hadn´t read that much about loans, and I found it so interesting and fresh! I just got a little bit confused with the collateral mechanism. As I understood you deposit a collateral into a platform where is locked (mainly to protect the loaning platform from the devaluation of the token) and the loan is what we call the utilization rate, and depending on the volatility the interest rate will increase or decrease. But I don´t understand why someone, lets say with 100 ETH as in the example, would risk their tokens to get 70% of what they already have and could use risk-free. Am I correct or I just didn´t understand it correctly? English is not my first language so that´s why I got a little bit messed-up. Thank you for your content! I listen to your podcast every morning when I´m working-out, and I read your newsletter everyday!