How can DeFi effectively respond to market turbulence after the Bybit hack?

Author: Omer Goldberg, Founder of Chaos Labs

Source: Omer Goldberg's X account

Compiled by: Yuliya, PANews

After Bybit faced a $1.4 billion hack, the cryptocurrency market experienced a severe shock. How DeFi (Decentralized Finance) platforms respond to this largest hack in history, along with potential contagion risks and USDe price fluctuations, has become the focus of attention in the crypto space. This article will delve into the impact of this attack on Aave, Ethena, and USDe, analyze how the DeFi system is responding to this event, and explore whether Proof of Reserves can prevent liquidations exceeding $20 million.

Following the attack, the Chaos Labs team, along with bgdlabs, AaveChan, and LlamaRisk, formed an emergency task force to assess the risks Aave might face and the systemic risks involved.

The emergency task force focused on several core issues: Bybit's solvency status, the possibility of larger-scale attacks, and the potential impact of any bankruptcy or write-down on Aave, considering the exposure to sUSDe.

Ethena Labs confirmed that its funds are custodied through Copper.co, but the market remains concerned about the chain reaction that could result from Bybit's inability to honor profits and losses, as well as whether USDe might face deeper decoupling risks.

Analysis of Bybit's bankruptcy risk reveals three main areas of concern: exposure risk due to failed hedging of USDe, chain liquidation risk triggered by falling ETH prices, and potential contagion risks in DeFi.

This prompted stakeholders to accurately quantify losses to decide whether to take measures such as freezing the sUSDe market. The transparency dashboard shows Ethena's ETH allocation on Bybit, while Ethena Labs' collateral is securely stored off-chain at Copper.co. This custodial solution and off-chain settlement mechanism effectively shielded Ethena and USDe from bankruptcy risks similar to those of the FTX exchange.

Assuming a $400 million "paper" nominal ETH position cannot be closed, and ETH prices drop by 25% before funds are released by Copper.co, Ethena could face $100 million in unhedged losses. However, considering a $60 million insurance fund, the total support loss for USDe is expected to be only 0.5%.

Based on a relatively controllable risk assessment, Aave prepared a risk response plan and continues to monitor the situation.

In terms of pricing, USDe exhibited significant price discrepancies across different trading venues. On the Bybit platform, due to panic selling and a lack of immediate arbitrage, USDe/USDT briefly fell to $0.96.

In contrast, on-chain pricing remained more stable, with only a brief decoupling to $0.994, quickly restored through arbitrage. This difference primarily stems from the redemption mechanism and the role of oracles.

Unlike CeFi, USDe redemption can be continuously and atomically conducted on-chain through Mint and Redeem contracts. The on-chain redemption mechanism for USDe operated smoothly, completing $117 million in redemptions within hours. Ethena Labs also raised the redemption buffer to $250 million and maintained price stability through continuous replenishment until USDe regained its peg. Due to the atomic nature of USDe redemptions, whitelisted redeemers quickly bridged the price gap on Curve.

However, anomalies in the oracle amplified market risks. Chainlink's USDe/USD price oracle deviated from on-chain prices, dropping to $0.977, even though the redemption mechanism continued to operate normally.

This deviation led to $22 million in liquidations on Aave, as traders were liquidated due to secondary market price fluctuations, despite their USDe assets being well-collateralized.

This highlights the room for improvement in the oracle mechanism. An integrated smart data source with Proof of Reserves could provide a more accurate valuation of USDe, avoiding unnecessary liquidations by considering real-time redemptions rather than relying solely on the weighted average trading price. Such a smart oracle could:

• Prevent unnecessary liquidations;
• Maintain capital efficiency;
• Reduce market pressure.

What areas can be improved?

Risk, price, and Proof of Reserves data must work in synergy rather than in isolation to ensure value and maintain the resilience of the DeFi system under stress. Price oracles should reflect the true collateral support rather than just secondary market prices.

Overall, the DeFi ecosystem has withstood this stress test. The Bybit team stabilized the market through transparent communication, the Ethena Labs team quickly mitigated risk exposure, ensuring smooth redemptions, while Aave effectively controlled risks without incurring bad debts.

This incident indicates that to build a more resilient system, the industry needs smarter oracles and risk-aware infrastructure that enhance capital efficiency while ensuring safety. The arrival of the next major stress test is only a matter of time, and the industry needs to prepare in advance.