Aave Loses Top DeFi Spot as $293M Kelp DAO Exploit Sparks Bad Debt Crisis

• Aave’s TVL lost its position as the biggest DeFi protocol by Sunday, with a decline from $26.4 billion to $18.6 billion.
• The quickness with which Aave’s TVL collapsed demonstrated how dangers posed by a single security breach may ripple over the larger, more interdependent DeFi lending industry.

Over the weekend, the total value locked onto the decentralized lending protocol Aave fell by about $8 billion. This was due to the fact that the hackers responsible for the $293 million Kelp DAO attack borrowed funds on Aave, leaving the protocol with around $195 million in “bad debt” and prompting withdrawals. According to data compiled by DeFiLlama, Aave’s TVL lost its position as the biggest DeFi protocol by Sunday, with a decline from $26.4 billion to $18.6 billion.

Liquidity Crisis

The lending pools for USDT and USDC on Aave v3 are now at 100% utilization. Until fresh liquidity comes or borrows are returned, more than $5.1 billion worth of stablecoins cannot be withdrawn. The quickness with which Aave’s TVL collapsed demonstrated how dangers posed by a single security breach may ripple over the larger, more interdependent DeFi lending industry, perhaps triggering a catastrophic liquidity crisis.

Hackers started the issue on Saturday by taking 116,500 rsETH tokens, which are worth around $293 million, from the LayerZero-powered bridge of Kelp DAO and using them as collateral to borrow wrapped Ether (wETH) on Aave v3.

According to Lookonchain, the transaction resulted in around $195 million in “bad debt” for Aave, which sent the Aave token price down by over 20%, from $112 at 6:00 pm UTC on Saturday to $89.5 roughly 25 hours later. Among the biggest crypto whales to withdraw assets from Aave, according to Lookonchain, were Abraxas Capital with $392 million and the MEXC crypto exchange with $431 million.

Curve Finance, a DeFi platform, Ethena, a stablecoin issuer, and Wrapped Bitcoin (WBTC), a BitGo product, are among the crypto networks and protocols that have temporarily disabled the LayerZero bridge in the meanwhile.

Aave said that it has frozen the rsETH markets on Aave v3 and v4 shortly after the Kelp DAO hack to stop any suspicious borrowing. Subsequently, it clarified that rsETH on Ethereum mainnet is still completely backed by its underlying assets.

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