Aave’s recently unfrozen WETH market on Ethereum is facing scrutiny after a key DeFi strategist highlighted a looping leverage strategy that could offer yields as high as 45 percent, creating significant liquidity risk for the protocol.
"The current interest rate model is not safe," MonetSupply, strategy lead at Spark Protocol, said in a public statement. He argued the parameters allow for a high-yield looping strategy with Liquid Staking Tokens (LSTs) and Liquid Restaking Tokens (LRTs) that could drain liquidity, preventing ordinary users from withdrawing their assets.
The strategy involves users depositing LSTs/LRTs, borrowing WETH, swapping the WETH for more LSTs/LRTs, and repeating the cycle to maximize leverage. While profitable for a few, this could create a severe liquidity shortage for the underlying aEthWETH pool on Aave, potentially leading to a "bank run" scenario where withdrawal requests cannot be met.
This new warning highlights systemic risk within the DeFi ecosystem and comes at a precarious time for Aave. The protocol is still navigating the consequences of a recent $292 million exploit at Kelp DAO, which saw attackers drain rsETH, a type of LRT. That event, attributed to North Korea's Lazarus Group, has already caused nearly $10 billion in value to exit Aave, according to DefiLlama data, as the protocol assesses up to $230 million in potential bad debt.
The Kelp DAO incident on April 20 targeted a LayerZero-powered bridge, with attackers compromising RPC nodes to illegitimately mint rsETH. While Arbitrum's Security Council successfully froze 30,766 ETH (worth over $71 million) of the stolen funds, the exploit has intensified the debate around the security of cross-chain bridges and the risks associated with LRTs. The new concerns raised by MonetSupply suggest that even without an exploit, the current market dynamics and protocol parameters on major platforms like Aave could lead to instability.
This article is for informational purposes only and does not constitute investment advice.
