What Brings Capital Back to DeFi? | Roundup

DeFi exploit losses over roughly one month totaled approximately 500 million dollars, split between the Drift exploit at around 285 million dollars and the Kelp DAO exploit at a similar amount. The Kelp DAO breach originated from a Layer Zero DVN that Kelp DAO itself configured as one of one, creating a single point of failure. Approximately 97 percent of Layer Zero DVN setups were configured as one of one or two of two, suggesting the vulnerability was systemic. Chorus One had previously assessed Layer Zero as the most centralized and most at-risk interoperability network compared to Wormhole and Axelar, though whether the incident represents operator error or a Layer Zero design failure was not resolved.

The Kelp DAO incident caused direct contagion because RS ETH was listed as collateral on Aave Core. Aave deposits fell from approximately 45 billion to approximately 31 billion dollars in one week, a decline the speakers described as without clear precedent in TradFi terms given the absence of structured seniority rules for loss allocation. Morpho, which uses isolated markets rather than Aave's pooled model, also saw TVL fall approximately one billion dollars after curators made poor asset selections. The speakers concluded that both models require trust to be placed somewhere, either in protocol governance or in a curator, and neither has proven immune to losses. Vault curation is under particular scrutiny because most curators are not registered investment advisers, leaving users with little recourse after bad allocation decisions.

Lazarus Group obtained approximately two billion dollars in hack proceeds last year, and the speakers noted North Korea has infiltrated infrastructure layers, making exploits far more sophisticated than in prior cycles. A speculative theory raised was that Lazarus Group has been accumulating exploits and pushing them out before a tool called Mythos launches and identifies the vulnerabilities. Mythos is described as a massive overhang on the entire crypto space, with DeFi most exposed because it holds the most capital. The ongoing hacks are also damaging to regulatory clarity because key stakeholders receive intelligence briefings linking DeFi activity to North Korean weapons program funding.

All three speakers said they are not personally incentivized to deploy capital into DeFi right now because yields are below treasury rates and contagion risk is high. Crypto-native LPs are currently diversifying outside of crypto rather than deploying into DeFi. Zave predicted DeFi has likely reached a bottom and will take one to two years to recover with new protocols and primitives, while another speaker held that the next twelve months will be very challenging even for blue-chip protocols. Capital is predicted to return primarily when interest rates fall, making treasury yields less competitive. The speakers questioned whether DeFi can genuinely thrive in a sustained higher-rate environment or whether it is structurally dependent on low rates.

The GENIUS stablecoin bill has passed but implementation rules are not finalized until approximately November of this year, which is why no significant growth in compliant stablecoins has occurred yet. Meta and Stripe are both reportedly pursuing stablecoins, motivated by yield on underlying assets currently captured by banks. Coinbase is leading a coalition to allow stablecoin issuers to pass yield to holders, while banks are opposing this. If yield cannot be passed directly to holders under the GENIUS bill, demand is expected to drive more deposits into borrow-lend protocols like Aave. RWAs and RWA looping are predicted to be a significant driver of the next DeFi cycle, and within twelve to twenty-four months hedge funds and similar institutions may begin providing liquidity into DeFi yield opportunities if rates fall and speculation returns.

Aave deposits have fallen from approximately 45 billion to just under 30 billion, and the majority of that capital appears to be leaving DeFi entirely rather than rotating to competitors. Spark nearly doubled its Ethereum-side deposits and is a likely beneficiary of Aave outflows. There is no observable migration between Ethereum DeFi and Solana DeFi, which the speakers found surprising. The stickiness of DeFi capital to its native chain is stronger than expected, and Ethereum's uninterrupted uptime combined with the practical reality that most institutional funds receive USDC on Ethereum reinforces its structural advantage for large capital deployments.

A recurring structural problem identified is the deliberate offloading of liability between parties, illustrated by curators allowing risky assets without adequate due diligence, Layer Zero deflecting responsibility despite operating the relevant infrastructure, and Circle avoiding asset freezes to limit its own liability exposure. On-chain insurance was dismissed as a near-term solution because it lowers yield further and faces serious underwriting challenges. Consolidation is identified as the defining trend for DeFi over the next two years, with the expectation that strong teams will survive while many protocols fail due to the difficulty of combining financial acumen with smart contract security expertise. Institutional money is expected to drive the next cycle more than retail, but the speakers cautioned it is unclear whether current DeFi protocols are secure enough to handle a billion dollars or more in institutional deposits within the next six to twelve months.