Hyperliquid Vault Loss Incident

Event Overview: On March 12, 2025, the Hyperliquid vault (Hyperliquidity Provider) experienced a temporary loss exceeding $4 million. This loss was caused by a whale using 50x leverage who actively liquidated their position as the price of ETH fell, leading to the liquidation of up to 160,000 ETH (worth approximately $306 million) in long positions. Due to the massive amount, the ETH price continued to decline during the liquidation process, further exacerbating the loss, which was ultimately borne by the Hyperliquid vault.

Safety and risk control are always important topics for all exchanges, and this HLP incident has sounded an alarm for us. As an employee of a DEX, I would like to discuss the DEX vault from the perspectives of protocol mechanisms and risk management.

What is a DEX Vault

A DEX vault is generally divided into single-type vaults and composite-type vaults. A single-type vault is an innovative architectural design aimed at enhancing capital efficiency and user experience through centralized management and optimization of asset usage. As a smart contract system, a single-type vault centralizes the storage and management of all user assets, allowing users to deposit all assets into a unified contract, avoiding repeated authorization and asset transfer across multiple protocols. By reducing unnecessary token transfers and multiple approval operations, it can effectively lower gas fees. The assets within the vault can be used for various purposes simultaneously, such as providing flash loans, participating in yield farming, or serving as liquidity for AMMs.

In addition to its literal meaning of allowing users to deposit assets, a single-type vault also functions like a "Lego base plate," similar to a decentralized "app store." Developers can build various DeFi applications on this flexible underlying architecture. The core advantage of this model lies in its modular design, allowing developers to focus on application logic development while delegating the underlying token management and accounting to the vault. This separation enables developers to build complex functionalities more efficiently without having to design the underlying asset management system from scratch.

In traditional DeFi protocols, each application typically needs to manage its assets independently, which not only increases development costs but may also lead to asset fragmentation and inefficient capital utilization. A single-type vault, by centralizing asset management, provides a shared capital pool for multiple applications. This design allows developers to easily build various applications such as lending, liquidity mining, and yield optimization without worrying about the storage and management of underlying assets.

The earliest single-type vault can be traced back to March 2021, when SushiSwap launched its single vault, BentoBox. BentoBox allows developers to build applications such as the lending protocol Kashi and leveraged trading tools on it, enabling these applications to share the assets within the vault, thus achieving higher capital efficiency. Since the smart contracts of the vault have undergone rigorous audits and testing, it not only lowers the development threshold for ecological applications but also further enhances the overall security of the protocol.

Another important function of a single-type vault is to support synergies between various DeFi applications. By centralizing all assets in one vault, different dapps can connect and share assets, thereby forming a powerful network effect. Taking Balancer's V2 vault as an example, developers can freely build various AMM (automated market maker) strategies to utilize idle assets in the vault for farming or lending. Some traders even use single-type vaults for flash loans and arbitrage, allowing arbitrageurs to quickly switch between different capital pools, as the efficient liquidity model further amplifies the scale of profits.

The HLP vault that suffered losses in this news event is, strictly speaking, a composite vault composed of multiple strategy modules. Its main structure is divided into four parts: market making, order taking, funding rates, and trade liquidation.

Market making strategy calculates a fair price based on the quote data from DEXs and large centralized exchanges. The vault executes trades around this fair price, running limit and market order strategies, aiming to provide profitable liquidity 24/7 immediately after all assets are listed. Although this strategy operates off-chain to maintain speed and efficiency, the positions held by the vault, unfilled orders, trading history, deposits, and withdrawals are visible on-chain in real-time.

The vault's market making strategy not only provides depth and liquidity for traders but also reduces slippage through optimized quoting and order management. Community members (including institutions and retail investors) participate in market making by adding liquidity, thereby earning market maker profits. This model makes the DEX vault not just a passive liquidity provider but also an active market participant.

Order taking is a strategy that actively seeks profitable trading opportunities based on market dynamics and order book depth. It analyzes buy and sell orders on the order book, choosing to execute trades at appropriate price levels to earn the bid-ask spread. This strategy is similar to the "Taker" role in traditional trading, which actively takes orders rather than passively placing them.

The order taking strategy complements the market making strategy. The market making strategy maintains the depth and stability of the order book by providing liquidity, while the order taking strategy captures short-term profits from market fluctuations through active trading. This synergy allows the vault to flexibly adjust strategies under different market conditions to maximize returns.

Funding rates, in the perpetual contract market, are mechanisms used to adjust the cost of long and short positions. The vault generates additional revenue for the platform by participating in the collection of funding rates. When there are too many positions in one direction in the market, the funding rate becomes high, and the vault can earn this fee by providing liquidity in the opposite direction. This mechanism not only helps the DEX generate revenue but also balances the long and short positions in the market through funding rate adjustments, thereby maintaining market stability.

Liquidation strategy, like market making, is one of the two most stable ways to make money in DEX trading, and the vault naturally takes on the responsibility of handling liquidation operations on the platform. When a user's position faces liquidation due to insufficient margin, the vault takes over these positions to ensure the healthy operation of the platform. (The crux of the HLP incident lies here, which I will elaborate on below.) By participating in liquidation, the vault can not only earn liquidation profits but also further optimize its overall risk exposure by managing liquidation positions.

Through these four strategies, the composite vault provides strong liquidity support and revenue sources for the DEX platform. These strategies not only enhance the overall efficiency and stability of the platform but also offer users low volatility and high-yield investment opportunities. Therefore, not only Hyperliquid but also several other DEXs, including Antarctic Exchange, currently utilize such vault designs.

DEX Risk Management

Now let's review what exactly happened with HLP. A trader converted $10 million USDC into a $271 million long position in ETH using high leverage, then withdrew the collateral, forcing HLP to take over the trade. The trader ultimately made a profit of $1.8 million, while HLP suffered a loss of $4 million.

This perfectly utilized the liquidation strategy we discussed earlier. If the trader had directly traded at market price through the order book, they would have faced significant slippage losses. However, they cleverly used the withdrawal of collateral to indirectly force Hyperliquid to liquidate their position, leaving HLP with a staggering $286 million long exposure in ETH. The trader could immediately open a reverse short position on another exchange to hedge and profit from the short.

So why did Hyperliquid incur a loss of $4 million? It turns out that when the trader completed the collateral withdrawal, HLP was forced to take over a $290 million position. Under such immense pressure, the protocol could only quickly match trades, and due to limited market depth, significant slippage was inevitable. Of course, Hyperliquid also took timely measures, reducing the maximum leverage for BTC and ETH to 40x and 25x, respectively, and raising the margin requirements for large positions.

Since the vault's liquidation strategy requires it to passively take over user positions when users withdraw collateral to maintain protocol stability, some professional DEXs will take additional measures to maintain market stability during abnormal price fluctuations and extreme market conditions. For example, Antarctic Exchange has a dynamic risk control mechanism. AX (short for Antarctic Exchange) has designed trading risk limits for traders, categorizing them into different tiers based on trading volume and controlling the overall risk of the exchange according to these tiers.

In the event of severe market fluctuations, AX will reduce the maximum leverage that traders can use or maintain the margin ratio to lower the risks the exchange may face. Moreover, this mechanism is dynamic, adjusted by the internal risk control module of the protocol based on market conditions. This not only ensures the safety and stability of the DEX but also maximizes user engagement and enthusiasm for the market. Thanks to this mechanism, Antarctic Exchange currently achieves an LP yield of 32.72%.

Conclusion

Through the Hyperliquid vault incident, we can deeply understand the complexity and importance of DEX liquidity pools in terms of safety, yield, and risk control. Composite vaults provide strong liquidity support and revenue sources for the platform through various strategy modules (such as market making, order taking, funding rates, and liquidation). However, this complex structure also increases the potential for risk exposure under extreme market conditions.

The HLP incident revealed the significant risks that liquidation strategies can pose in extreme situations. When artificially induced severe fluctuations occur, the positions taken over passively may lead to substantial slippage losses. Therefore, DEX platforms need to pay more attention to the design of risk control mechanisms.

In the context of the rapid development of the DEX industry, safety and risk control will always be core issues. This incident reminds us that whether it is a single-type or composite-type vault, there is a need to continuously optimize risk control strategies while pursuing high yields.

Only through rigorous smart contract audits, reasonable strategy designs, and dynamic risk management mechanisms can DEX platforms achieve sustainable revenue growth while ensuring the safety of user assets. In the future, the DEX industry needs to continue exploring more efficient and safer vault architectures and risk management solutions to cope with the increasingly complex market environment and potential risks.

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