On-Chain Markets Update by Lucas Outumuro, Head of Research at IntoTheBlock
The risk of hacks in DeFi has been a pervasive hazard for seasoned participants in crypto for some time. While smart contract bugs can do damage to a protocol and its depositors, economic risks are also dangerous, and oftentimes these challenges are underestimated. The recent USDN de-peg highlights the importance that economic factors play when depositing into DeFi applications.
At IntoTheBlock, we have been researching risks in DeFi, and categorize them into two buckets:
- Technical risks — programmatic functions used in an adversarial manner to withdraw funds from protocols
- Economic risks — imbalances in key supply and demand metrics that create vulnerabilities that can result in protocol illiquidity and loss of deposits
Hacks and rug pulls exploit technical risks to get away with user deposits. Meanwhile, economic imbalances, such as the ones seen with USDN, can lead to billions in losses. Analyzing the 50 largest incidents across DeFi, we observe that just over half of all losses stem from economic risks.
The largest incident due to economic conditions was the collapse of the TITAN algorithmic stablecoin, which resulted in its market cap of $2B evaporating to zero within hours.
This time, another algorithmic stablecoin has been behind millions of value being lost. Neutrino, the team behind the USDN stablecoin, has been allegedly propping up the price of WAVES by borrowing in the Vires protocol and lifting the USDN market cap.
As soon as a pseudonymous Twitter user exposed this information, ripple effects were felt throughout markets related to Neutrino, in a similar fashion to what occurred following the Wonderland debacle.
This began as withdrawals from the USDN-3CRV pool spiked.
On March 30, prior to the exposé, the USDN pool in Curve had $260M in liquidity. Ten hours after 0xHamZ’s Twitter thread, users started withdrawing the 3CRV component of the pool.
In other words, depositors were opting to take their funds out of the 3CRV pool (which contains USDC, USDT and DAI) or in any of these three components, but not in USDN. This led to an imbalance in the asset composition in the pool, where USDN became an outsized proportion of the liquidity.
With these Curve pools, liquidity is meant to be distributed 50/50 between the metapool (in this case 3CRV) and the additional stablecoin. As the pool became 90% USDN, it became harder for its peg to sustain trading activity from users dumping the stablecoin in light of the uncertainty.
By the time the pool reached 70% at 2PM (EST) on Friday, USDN was still at $0.99, suggesting that this could have been a warning sign prior to the crash to $0.70.
As the USDN price crashed, many holders probably suffered losses. Moreover, those that exited the Curve pool incurred additional losses as exit fees escalated following the imbalance and increased share of USDN in the pool.
Even though we don’t know whether the USDN peg will recover, this episode shows the impact economic risks can make on DeFi protocols and their users. Ultimately, this is a complex risk vector affecting several supply and demand indicators. But it can be mitigated to a certain extent by being aware of these potential scenarios and monitoring relevant metrics.