Security experts reported on Saturday that nearly $300 million left Ethereum-based Kelp DAO on Saturday.
Cryptopolitical reported that Kelp DAO said it had “identified suspicious cross-chain activity related to rsETH” and paused rsETH contracts while it worked with security experts.
ZRO fell quickly, sliding 18% from $2 to $1.4. At the same time, a whale operating a leveraged long position on HyperLiquid was partially liquidated, losing $2.88 million.
This type of forced settlement sends a message. People see the liquidation, they don’t ask questions, they just walk away. Liquidity declines and price follows.
DeFi protocols freeze exposure as rsETH spreads risk everywhere
The problem got worse because rsETH is connected in too many places. This token is linked to credit markets, yield strategies, and leveraged loops across DeFi. On
Aave V3 has already frozen its markets. SparkLend has also closed the rsETH market. The liquid also froze the activity. Upshift has paused both the High Growth ETH and Kelp Gain vaults. Lido Earn through the Mellow Strategy Meta-Vault is involved, and this setup likely involved leverage.
Pendle PT and YT tokens are also included in this structure. Compound and Euler are part of the larger network, and some Beefy strategies may also be affected, with possible disclosure by Yearn.
Ignas also pointed out that LayerZero could be affected since rsETH was bridged by L2 networks. This raises a direct problem. If rsETH is stuck or broken on L2s, these tokens may have no real value at this time.
He added that the situation is still evolving and said he doesn’t want to spread fear, but also made it clear that there are “not a lot of places to hide in DeFi” during events like this.
The former CEO of Euler Labs explains how losses, liquidations and bad debts can skyrocket
Michael Bentley, former CEO of Euler Labs, said: “The consequences of the Kelp rsETH exploit will be chaotic and could potentially be far more serious than some people currently realize.”
He explained that while rsETH is still backed on the mainnet, there is no liquidity for sale and since the contracts are paused, “there is currently no viable repayment route either.”
Michael also read the numbers. If the losses were spread across all holders, rsETH would be about 81.25% of its original value, based on a loss of $300 million versus $1.6 billion.
However, he made clear that this approach was unlikely, saying it would “likely push a number of large positions on Aave toward under-collateralization and risk the creation of bad debt,” which could lead to litigation.
Michael also said that L2 holders would likely take the hit instead. He asked who these holders were and pointed out that they could be DAOs or funds that are currently suffering large losses. He added that affected users could take legal action to force a sharing of losses, which could delay repayment even further.
Michael said lending platforms are unlikely to accept rsETH as collateral again once redemptions resume. This means a massive unwinding of the looping trades between rsETH and ETH.
At the moment, these businesses are already bleeding. Aave ETH utilization is 100%, borrowing costs are 8.71%, and the return on ETH staked is around 2.5%. This means that the returns are deep in negative territory and range from around -6.21% to -90%.
Michael explained that the normal settlement process, which involves exchanging collateral and repaying debt, may not work on this scale. Without sufficient liquidity, traders may have to transact manually step by step.
Michael added“If rsETH ceases to be a collateral and no longer has lending power, it will also become much more difficult for people to transact it manually.”
If positions become stuck while interest increases, equity will be wiped out. Once debts grow beyond recoverable collateral, bad debts arise and continue to grow.
