The KelpDAO Hack and DeFi’s Stress Test | Ian Unsworth

The podcast discusses a significant hack involving the RSEath restaking token, linked to a Layer Zero contract, executed by North Korea. This marks their second attack in two weeks, following a socially engineered hack on Drift. The hosts express confusion over the nature of the hack, questioning whether it stemmed from a compromised key or incentivized usage on Layer 2s. They highlight the implications of the hack, particularly regarding who will absorb the losses and the existence of the assets involved.

Ian points out the surprising amount of stale capital on Ethereum and LRTs, noting that the perceived low risk of certain yield options contributed to the situation. Both hacks resulted in stolen funds ending up in ETH on Ethereum Mainnet. Following the hack, there was a rapid market response, leading to significant withdrawals from various protocols, with Aave experiencing a notable outflow of $1.9 billion, comparable to the FTX collapse in 2021. The hack involved approximately $200 million, raising concerns about security measures in DeFi protocols.

Participants emphasize the need for improved risk management and security protocols in DeFi, especially given the low interest rates that often do not compensate for the associated risks. The conversation touches on potential trading opportunities in the current market, while uncertainty remains regarding specific losses in RSEs and AVE markets. Although stablecoin markets appear relatively stable, hacks lead to sell-offs that affect collateral.

Lawnmaris has assumed the role of sole risk manager for Aave after Chaos Labs' departure, managing the situation effectively despite criticism regarding collateral listings. Significant redemptions in USDS and USDE, totaling over $600 million, are noted, with sophisticated actors able to unwind positions quickly, while some protocols, like Avant, struggled. Concerns arise over excessive looping of stablecoin strategies, which could lead to panic and liquidity issues. The conversation speculates on future liquidity crunches related to tokenized private credit funds and other on-chain credit products, contrasting a "K-shaped economy" on-chain where capital is held for various reasons, including illicit activities and tax avoidance, versus those in more established capital markets.

The discussion highlights that some investors opt for stablecoins despite lower returns compared to off-chain options, often due to tax considerations or limited local opportunities. The security council's decision to freeze 30,000 ETH linked to a hack is examined, with one speaker asserting that such actions are crucial for maintaining platform integrity and user trust. They argue that allowing hackers to keep stolen funds would set a dangerous precedent.

The implications of Layer 2 (L2) solutions are examined, with a speaker cautioning against a purely anarchist ideology, as L2s operate under a single sequencer model. Risks associated with single sequencer chains are underscored by Scroll's recent activities, where a cashback incentive program and a significant increase in gas prices raised concerns about potential malicious practices. This situation contrasts with the more stable practices of platforms like Arbitrum, reflecting broader issues of fee manipulation and user trust in the crypto space.

The conversation also touches on Kyros Research's proposals for USDE, including backing with tokenized gold and white label stablecoins. While there is speculation about whether these proposals could have insulated USDE from the recent RSE hack, the response indicates a lack of direct correlation. The looping mechanism of USDE, which allows users to borrow and mint new tokens through collateralized processes, is explained, alongside its relationship with Aaveg for generating returns.

The discussion highlights the disparity in daily payouts to stablecoin issuers compared to fees across major chains, emphasizing the importance of yield. Jupiter's stablecoin issuer has scaled successfully, while MegaEath's strategy to utilize yield for token buybacks is seen as a positive feedback loop. The current lack of structural bids for altcoins and yield for stablecoin holders is noted, alongside proposals to enhance USDE's backing with tokenized gold and the growing interest in commodities like oil and gold.

The need for diversifying yield for USDE holders to surpass the risk-free rate is emphasized, with Sky's success in achieving yield through various methods mentioned. Collaboration potential between protocols like Sky and Spark is acknowledged, alongside Athena's recent $1 billion in redemptions while remaining over 100% collateralized. The demand for yield capture in the DeFi space is recognized, with MegaEath and Gupusd highlighted as examples.

Participants discuss MegaEath's frustration regarding the delay in achieving key performance indicators (KPIs) for their stablecoin, which, once met, could enhance the ecosystem's activity and the launch of MegaToken. They highlight Jupiter as a leading ecosystem application with significant lock-in effects, noting its potential to grow a stablecoin despite a recent drop in market cap due to withdrawals. Competing stablecoins like PiUSD and PayPal's PYUSD are also entering the market, often offering attractive reward rates to draw users.

The conversation shifts to Kairos and 00 Edge, with inquiries about their role in running validators across different chains, including Solana. One participant confirms that 00 Edge has positively impacted Solana validators by providing stake matching incentives and new revenue streams through the monetization of Shreds. This utility could extend beyond Solana, enhancing data transfer applications.

Discussion on revenue models emphasizes the need for alignment between revenue generation and token value, with suggestions for Solana to explore revenue-sharing agreements with Circle. The participants debate what aspects should be protocolized, using Gito and double zero as examples, and express concerns about competition in block building potentially leading to inconsistencies.

The conversation also addresses the architecture of crypto networks, where contributors are rewarded based on link utilization, emphasizing the importance of proportional rewards akin to Bitcoin mining. The impact of block building on internet services for validators remains uncertain, but private internet access could improve response times and attract non-Solana validators. Market dynamics are explored, with the potential benefits of hyper liquid markets and trading activity from private fiber access. Concerns arise regarding validator distribution, particularly the dominance of AWS, which could stifle competition. Future developments, such as Hyper EVM's introduction of priority fees, may increase competition in block billing. Ian concludes the discussion by expressing appreciation for the insights shared, looking forward to future conversations.