Author: Duo Nine

Translated by: Deep Tide TechFlow

I don't think people realize how bad the situation is for @aave right now.

All core markets reached 100% utilization, with $3 billion of USDT and $2 billion of USDC stuck!

This means you cannot withdraw your funds.

A long article explaining why and how we got to this point.

When the rsETH exploit occurred and AAVE incurred bad debt, figures like Justin Sun, MEXC exchange, and other whales immediately withdrew billions from AAVE.

This instantly drained all available liquidity from key core markets like ETH, USDT, USDC. Those who withdrew early escaped, while those who were a step behind got trapped.

Initially, the ETH market reached 100% utilization, meaning you could not withdraw your ETH from AAVE.

Worse still, this also means the protocol cannot handle ETH liquidations if the ETH price drops/crashes. If you cannot sell any ETH, you cannot liquidate to cover debt obligations.

This means AAVE runs a greater risk of generating more bad debt as its markets remain stuck.

Even so, users can still sell aETHwETH tokens on Uniswap or similar aggregators at a slight loss. This is the last exit door for ETH depositors on AAVE.

Depositors of USDT and USDC cannot do so. They are trapped.

This is because AAVE has lost over $6 billion in liquidity in the past 24 hours. As whales took out their funds, USDT and USDC also reached 100% utilization.

These markets are now also stuck, with funds locked. Panic is spreading, and desperate measures are needed in this critical moment.

Some users decided to borrow USDT/USDC as collateral and exit through other markets with a 10-25% loss (90-75% LTV). Essentially, you borrow GHO/DAI/USDe to counter your locked USDT/C.

But as more liquidity leaves AAVE, more markets are reaching 100% utilization and becoming locked/stuck due to low liquidity. This is rapidly spreading to all available markets.

Fortunately, the crypto market is relatively stable today, so the risk of liquidation is minimal, but if the situation changes, the billions of dollars locked on AAVE will not be able to handle liquidations = more bad debt for AAVE.

If trapped users or related protocols need to access their funds to prevent liquidations or other critical functions, they will face huge problems.

Moreover, no one wants to deposit (or provide liquidity) in these markets right now because your ETH, BTC, USDC/T could get stuck there, who knows for how long.

Once any available liquidity appears, it is immediately snatched away by bots, racing to escape. As I write this, I saw $250,000 in USDC liquidity disappear in a matter of seconds.

Then there's the bad debt issue.

AAVE has incurred over $200 million in bad debt through rsETH, which is like a hot potato. No one knows who will ultimately pay this bill.

If you haven't removed your assets from AAVE, you are at risk of receiving a portion of this bill in some form. Being unable to access your funds is also part of this risk.

The contagion risk is also extremely high.

Many protocols and applications rely on AAVE to implement their earning mechanisms. These protocols and their users are also trapped and may be forced to incur bad debt for no good reason.

October 10 is a CEX-driven crash, an epic failure in DeFi risk mitigation.

AAVE should never have introduced rsETH as a collateral asset, at least not on the scale of hundreds of millions, which allowed hackers to borrow over $200 million worth of ETH after releasing fake collateral.

Rumors on X suggest that rsETH was introduced by AAVE due to a service provider's conflict of interest (lobbying). If true, this represents a major failure in its governance structure (nothing new).

The team managing rsETH, @KelpDAO, is also facing a tough decision: who will actually pay for the $200 million loophole? AAVE users? L2 rsETH users? Will everyone affected have to suffer losses to make up for it?

Since the exploit occurred, the AAVE team and its founder Stani have remained silent for over 20 hours since initially announcing the freezing of the rsETH market.

They have a considerable problem on their hands, as the entire protocol is now at risk. Trust has been lost, as AAVE's TVL is dwindling by billions, causing all core markets to reach 100% utilization.

Perhaps some key players in the space will step in to provide liquidity to stabilize the market on AAVE before things get worse.

I was lucky to escape AAVE early when I first saw this. I also removed all assets from DeFi and will not touch any protocols in the coming weeks. The risk is too great for a few percentage points of gain.