Kelp DAO hack triggers "DeFi chain reaction": Aave faces potential bad debt of up to $230 million

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The Kelp DAO hack that shook the crypto world over the weekend not only caused significant losses for the protocol itself but also impacted Aave, the world's largest DeFi lending protocol. Depending on the subsequent resolution plan, Aave could face a massive loss of up to $230 million, drawing intense market attention. According to reports released by Aave Labs and risk management service provider LlamaRisk, the core of this crisis stems from "rsETH," the liquid restaking token issued by Kelp DAO. To enable rsETH to move across different blockchains, Kelp DAO relies on a "cross-chain bridge" mechanism, which locks tokens on the source chain before minting equivalent wrapped tokens on the destination chain. However, the hacker exploited a blind spot in this mechanism's security. By forging a seemingly legitimate cross-chain transfer message, the attacker successfully deceived the system into approving the transaction without any actual tokens being transferred from the source. This meant the hacker minted tokens out of thin air with no asset backing, effectively draining 116,500 rsETH from the Ethereum cross-chain bridge. The report indicates that after the hack, the attacker did not immediately dump the tokens on the open market. Instead, they deposited 89,567 rsETH into Aave as collateral and borrowed approximately $190 million worth of ETH and related assets on Ethereum and Arbitrum. This "empty-handed" maneuver instantly exposed Aave to extreme bad debt risk, leaving the protocol holding worthless, low-quality collateral. Facing the sudden crisis, Aave Labs emphasized that the team took immediate action to mitigate the damage. Within hours, they fully froze all rsETH markets, slashed the Loan-to-value ratio to zero, and blocked all new borrowing using the asset as collateral. How this massive bad debt will be resolved largely depends on how Kelp DAO plans to fill the funding black hole. The report outlines two potential scenarios: - If Kelp DAO decides to have all rsETH holders share the loss, the token is estimated to face a de-peg of approximately 15%, which would result in about $124 million in bad debt for Aave. - If Kelp DAO chooses to limit the losses entirely to Layer 2, the impact would be far more severe, with Aave's bad debt potentially soaring to $230 million, concentrated heavily on networks like Arbitrum and Mantle. As the incident unfolds, market panic has spread rapidly. Investors are concerned that some lending positions on Aave are backed by mispriced or under-collateralized assets, significantly increasing the risk of under-collateralized loans. Faced with high uncertainty, users have been withdrawing funds en masse to protect themselves. Following the hack, Aave saw its Total Value Locked (TVL) drop by approximately $6 billion. The report shows that the Aave DAO treasury currently holds about $181 million in assets and is actively negotiating with other participants in the ecosystem to find a solution to cover potential losses. However, because Kelp DAO has yet to announce a clear loss-sharing plan, the final financial impact on Aave remains unknown.

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