Original | Odaily Planet Daily (@OdailyChina)

Author｜Azuma (@azuma_eth)

The Aave bad debt incident, which has been causing upheaval for over a week, is basically coming to an end.

As DeFi United has raised enough funds to solve the problem (as of the publication, 132704 ETH has been raised, worth about 302 million USD), Aave officially released a technical implementation plan on April 28 at noon regarding the restoration of rsETH collateral status and the normal operation of the market.

• Note from Odaily: For the backstory, please refer to “DeFi was hacked again for 292 million USD; is Aave now unsafe?”; “The three-party game under the 290 million hole: who will bear the cost, Aave, L0, or Kelp?”; “Aave is giving up the throne of DeFi lending due to its own stupidity.”

Background Recap

The details of how Kelp DAO lost 116500 rsETH don’t need to be elaborated; the focus is on the flow of the stolen funds afterward.

After the hacker succeeded, they first dispersed the 116500 rsETH to multiple addresses. A portion was used as collateral deposited into Aave V3 on the Ethereum mainnet to borrow WETH, another portion was bridged to Arbitrum and used as collateral to borrow WETH on that network, and the remaining small portion of stolen funds was transferred through different channels.

Currently, 7 addresses related to the hacker still hold active rsETH collateral positions on Aave and Compound, accounting for about 107000 of the originally stolen 116500 tokens.

Solution

To achieve the restoration goal, Aave has set two objectives in its proposed implementation plan. The first is to restore the collateral support for rsETH; the second is to clear the affected positions in lending markets such as Aave and Compound to recover about 107000 excess collateral assets, thus restoring the damaged market.

First, let’s talk about the first goal—restoring the collateral support for rsETH.

The current rsETH is essentially in a “bankrupt” state; although the underlying staked ETH remains intact, the hacker has escaped through collateral borrowing, and the existence of this gap has caused the exchange rate of rsETH to ETH to become “decoupled”.

Therefore, Aave mentioned that to restore the collateral support for rsETH, the exchange ratio between rsETH and ETH needs to be pulled back to 1:1.07. This will be promoted through DeFi United, which has now committed enough ETH to restore the system's full operation, but the final execution still depends on governance approval, execution scheduling, and the signing of relevant agreements.

If the plan can proceed smoothly, DeFi United will completely restore the collateral support for rsETH by depositing ETH into the bridging lock-up contract for rsETH (RSETH_OFTAdapter 0x85d456b2…98ef3). The specific process is as follows:

• Gradually convert DeFi United’s ETH into rsETH;
• Transfer these rsETH to the relevant lock-up contract;
• Enable the bridging system to safely restore and operate fully.
• LayerZero and Kelp DAO will implement additional security measures to ensure safety after the bridge restoration.

Next, let’s look at the second goal—clearing the affected positions in the lending market.

After the collateral support for rsETH is restored, theoretically there should be no bad debts in Aave's lending market (at this point the collateral value exceeds the borrowed value), but it is still necessary to clear several anomalous collateral positions related to the hacker (expected to recover 13000 ETH) to restore normal market operations.

In this regard, Aave stated it will sequentially initiate governance proposals on Ethereum and Arbitrum to clear anomalous positions through a “controlled liquidation process”. The specific resolution process is:

• Temporarily adjust the oracle price of rsETH to trigger efficient liquidation;
• A temporary shortfall will occur during the liquidation process (subsequent steps will make up for this shortfall);
• The recovered rsETH collateral will be transferred to a multi-signature address managed by DeFi United.

Aave emphasized that the above parameter adjustments are only temporary measures used for restoration execution, and all adjustments will be reverted after completion, which will not have a long-term impact on the Aave protocol. During the problem-solving period, WETH and rsETH deposits on the Ethereum mainnet, Arbitrum, Base, Mantle, and Linea will remain frozen.

The ideal situation after the liquidation is as follows: the rsETH price oracle will be restored; the recovered rsETH will be exchanged for ETH through the standard redemption process of Kelp DAO; these ETH will be used to fill the shortfalls in Aave's markets on Ethereum and Arbitrum.

As for Compound, a similar clearing method will also be employed, and with DeFi United providing liquidity support, it is expected to recover an additional approximately 16776 ETH.

Once both major objectives are effectively completed, Aave will lift the suspension and freezing status of rsETH and ETH in all related markets, and then restore the loan-to-value (LTV) ratio and other parameter configurations for ETH and other assets.

Unresolved Issues

Aave additionally noted that although the above plan is expected to achieve restoration goals without socialized losses, there are still several uncertainties.

Firstly, although enough ETH commitments have been secured, the deployment of funds still relies on the final protocol and governance approval; secondly, the clearance of affected positions depends on smooth passage and execution of governance proposals; thirdly, if the attacker deliberately interferes, it may lead to incomplete formation of shortfalls, requiring additional liquidation steps; and fourthly, while LayerZero and Kelp have deployed additional security measures, residual risks still exist before verification in the production environment;

However, regardless of this, the incident of “Kelp DAO being hacked, and Aave's bad debt” that has disturbed the DeFi market for a long time seems to finally be approaching an end, and what remains to be seen is whether the plan can be implemented as expected in the actual environment.

As Andy, the founder of The Rollup, commented: “The next few days are crucial for DeFi; it is a daunting task that must be completed both quickly and safely. This is both a technical challenge and a test of social collaboration. Witnessing the real-time development of this is truly surreal.”

Hope good luck stands on the side of DeFi.

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