The butterfly effect of Balancer's hack: why did $XUSD become unpegged?

Author: Omer Goldberg

Compiled by: Deep Tide TechFlow

Summary

Hours after the multi-chain platform @Balancer encountered a vulnerability attack that triggered widespread uncertainty in the DeFi space, @berachain urgently executed a hard fork, and @SonicLabs froze the attacker’s wallet.

Subsequently, the price of Stream Finance's xUSD stablecoin significantly deviated from its target range, exhibiting a clear decoupling phenomenon.

Long-term issues resurface again.

The long-standing controversy surrounding leverage operations, oracle construction, and proof of reserves (PoR) transparency has once again come to the forefront.

This is a typical case of a “reflexive pressure event” outlined in our article “The Black Box/Vault of DeFi” last Friday.

What happened?/Background

The Balancer v2 vulnerability has erupted across multiple chains, and it remains unclear which liquidity pools are affected and which networks or integrated protocols are directly exposed to risks for a considerable period of time.

Capital panic in an information vacuum

In a vacuum of information, the reaction of capital remains the same: depositors rush to withdraw liquidity from anywhere they believe may be directly or indirectly affected, including Stream Finance.

Controversy over lack of transparency

Stream Finance currently does not maintain a comprehensive transparency dashboard or Proof of Reserve; however, it provides a link to the Debank Bundle to display its on-chain positions.

However, after the vulnerability outbreak, these simple disclosures failed to clearly address the issue of risk exposure: the price of xUSD (Stream's overlay yield dollar product) dropped from the target price of $1.26 to $1.15, and has now rebounded to $1.20, while users report that withdrawals have been suspended.

The Risks and Controversies of Stream Finance

Stream is an on-chain capital allocation platform that utilizes user funds to operate high-return, high-risk investment strategies.

The construction of its investment portfolio utilizes significant leverage, making the system more resilient under pressure. However, the recent controversy surrounding the recursive loop/minting mechanism has drawn public attention to the protocol.

Although the current situation does not directly indicate a liquidity crisis, it reveals the market's high sensitivity. When negative news arises and confidence is questioned, the shift from “possibly no problem” to “immediate redemption” is often very rapid.

xUSD is used as collateral, distributed across multiple chains in Curated Markets, including Euler, Morpho, and Silo, which cover ecosystems such as Plasma, Arbitrum, and Plume.

The protocol itself has significant risk exposure in these markets, with the largest amount being 84 million USDT borrowed against xUSD on Plasma.

Collateral mechanism and risk buffer

When the market price of xUSD falls below its book value, the related positions are not immediately liquidated. This is because many markets do not link the value of collateral to the spot AMM (Automated Market Maker) price, but rather rely on hard-coded or “fundamental value” feeds, which track reported asset support rather than the current secondary market price.

In calm periods, this design can alleviate tail risk liquidation caused by short-term fluctuations, especially in stable products. This is also one of the reasons why DeFi protocols performed better than centralized platforms during the liquidation wave on October 10.

However, this design may also quickly transform price discovery into trust discovery: choosing a foundational (or hardcoded) oracle requires thorough due diligence, including the authenticity, stability, and risk characteristics of the asset support.

In short, this mechanism is only applicable when there is a comprehensive Proof of Reserve and the redemption can be completed within a reasonable time. Otherwise, the risk is that the lender or depositor may ultimately bear the consequences of bad debts.

Stress test on Arbitrum

Taking Arbitrum as an example, the current market price of the MEV Capital Curated xUSD Morpho Market has fallen below the LLTV (Lowest Loan-to-Value ratio). If the pegged price of xUSD cannot be restored, the market may further deteriorate under the conditions where utilization reaches 100% and borrowing rates soar to 88%.

We are not opposed to basic oracles; on the contrary, they play a crucial role in preventing unfair liquidations caused by short-term volatility. Similarly, we do not oppose tokenized or even centralized yield-bearing assets. However, we advocate that when deploying money markets around these assets, fundamental transparency must be achieved, and modern, systematic, and professional risk management must be employed.

Curated Markets can be an engine for responsible growth, but they must not devolve into a race that sacrifices safety and rationality in pursuit of high returns.

If a “domino effect” type of complex structure is built, then one should not be surprised by its collapse when the first gust of wind blows. As the industry becomes more specialized and certain yield products become more structured (but potentially more opaque for the end user), risk stakeholders must raise their standards.

Although we hope to ultimately resolve the issues for the affected users properly, this incident should serve as a wake-up call for the entire industry.