Did DeFi just betray its own principles?

The recent hack on the liquid restaking protocol Kelp, resulting in approximately $290 million in unbacked RSEs and subsequent bad debt on Aave, triggered an unusual community response: DeFi United. This initiative saw major organizations and individuals pooling funds to cover the shortfall, raising over $300 million. The panel discussed whether this was the optimal solution, with a general consensus that while inspiring and effective in the short term, it highlighted the need for more sustainable, replicable, and preventative risk management for DeFi. Dean, an accelerationist, suggested that an alternative solution, such as a loan structured with interest and collateral from the involved protocols (Aave, LayerZero, and Kelp), would have been a better long-term outcome. This would have further entrenched the idea of DeFi's anti-fragility and set a precedent for self-healing systems, moving away from reliance on donations from wealthy individuals. Binge echoed this sentiment, acknowledging the immediate effectiveness of DeFi United in mitigating contagion risk but emphasizing the opportunity to evolve towards permanent risk infrastructure rather than just plugging holes. He stressed the importance of preventing such gaps in the first place, advocating for market mechanisms over social ones for future resolutions. David expressed concern that the solution, led by an individual like Stani, relied heavily on trust, which contradicts the core crypto principle of "don't trust, verify." He questioned whether this heroic effort could be replicated in future crises and hoped for conversations about long-term solutions that don't depend on the generosity of the wealthiest. The discussion then delved into potential alternative solutions. Dean elaborated on his loan proposal, suggesting terms where LayerZero and Kelp would bear the majority of the burden, with Aave contributing a minority due to its perceived lesser culpability. He believed that treasuries with substantial ETH holdings would have been amenable to such a low-risk, favorable loan agreement. Binge saw merit in loan structures but acknowledged the reactive nature of the current situation, making a complex structured product difficult to implement swiftly. He reiterated that the primary focus should be on preventing such incidents. David strongly favored Dean's loan idea, seeing it as permissionless, protocol-level, and reinforcing the concept of DeFi solving its own problems through market mechanisms rather than generosity. He also drew parallels to Bitcoin's founding principles against bailouts, highlighting the difference between bailing out centralized entities and supporting permissionless DeFi stakeholders who receive something in return for their contribution. A key point of contention was whether DeFi United constituted a bailout. David argued that while not a bailout in the traditional sense of government intervention, the reliance on donations from entities like EtherFi, which had no direct involvement in the hack, indirectly impacted their users and treasury. He questioned the clear-cut nature of it not being a bailout when treasury funds, potentially meant for user benefits, were diverted. Binge countered that such donations often went through governance processes, implying user consent, and that it was in the best interest of many protocols for Aave to recover, thus being good business rather than a pure bailout. He also drew a parallel to J.P. Morgan bailing out the US government in 1893, noting that private individuals acting in their own interest could perform similar functions, though he acknowledged the unsustainable nature of such mechanisms. David, however, maintained that plugging a hole of bad debt for an institution in crisis to prevent economic collapse was indeed a bailout, but differentiated it from the 2008 bailouts due to DeFi's permissionless nature and broader stakeholder benefits. The idea of bailing out users directly was seen as a more positive aspect. Regarding responsibility, there was a consensus that Aave and Stani received disproportionate blame and workload, while LayerZero and Kelp, the direct perpetrators, were less scrutinized. The discussion touched upon technical solutions and preventative measures. Dean suggested that DeFi needed its own version of L2 security and transparency, with public risk pages for major collateral assets to clearly outline contagion risks. He also proposed a standing incident response facility or public good to set standards for handling such events. David advocated for technical solutions like circuit breakers and pausing transactions or withdrawals during unusual activity, especially when large sums moved rapidly from bridges. He argued that the current market, designed for smaller economies, was ill-equipped for the billions in DeFi, necessitating a degree of "slowness" or delayed transactions to mitigate risk. The impact on DeFi's path to mainstream adoption was a significant concern. The panel agreed that the outcome of this incident and the subsequent implementation of preventative measures would heavily influence institutional and fintech adoption. A lack of clear, sustainable solutions and continued reliance on trust would likely lead to increased skepticism. David proposed a "socialist" approach for Ethereum, suggesting a tax system on gas fees to create a reserve fund for incidents, enabling redistribution and support for the ecosystem, similar to a government's role but with a focus on stakeholders. This was met with some pushback regarding its libertarian ideals. Binge clarified the Ethereum Foundation's (EF) role, stating their focus on funding core infrastructure and public goods not covered by others. He saw DeFi United as a testament to the ecosystem's growing strength and self-sufficiency, aligning with the EF's philosophy of subtraction. He also noted that for institutions, decentralization often equates to counterparty risk, and this incident highlighted that risk, making transparency and clear labeling of risks crucial for future adoption. He suggested that L2s, like Arbitrum, with their ability to coordinate and implement backstops, might be more appealing to institutions than Ethereum mainnet due to their perceived ability to recover funds, even if it introduced some centralization. David countered that Arbitrum's ability to freeze assets, while providing a solution, still raised concerns about the trade-off between decentralization and centralized intermediaries. He stressed the need for truly decentralized solutions to make a compelling case for blockchain over traditional finance. The debate also touched upon the lack of clear rules and frameworks for incident response, drawing parallels to Lehman Brothers. The panel agreed that transparency and auditability were paramount, calling for greater scrutiny of single-point-of-failure mechanisms like one-of-one signers on bridges. The mispricing of risk in DeFi was another key takeaway. The current yields were seen as not adequately reflecting the hidden risks, leading to a situation where users were unable to withdraw funds due to unforeseen consequences of protocol interactions. The panel emphasized that decentralization without transparency was merely marketing and that the industry needed to self-police and push for greater openness. They also discussed the potential for DeFi insurance to gain traction, although its current cost was a barrier. Contrarian takes included David's observation that Ethereum's "wholesome" image was proven true, but also highlighted its weakness compared to more cutthroat models, making it less replicable. He and others also criticized the Ethereum Foundation for not stepping in more directly to support Aave, a major customer, during the crisis, suggesting a perceived lack of hands-on support for builders compared to other foundations. Binge defended the EF's mandate of decentralization but acknowledged the frustration it could cause for builders seeking more immediate support. Ultimately, the consensus was that while DeFi United was a positive demonstration of community resilience, it exposed the immaturity of DeFi and the need for robust, transparent, and decentralized risk management systems. The incident served as a wake-up call to address hidden risks, improve security, and ensure that DeFi is truly "military-grade infrastructure" capable of withstanding state-level attacks, especially as it moves towards broader adoption and serves real-world users. The conversation concluded with a call for greater vigilance, transparency, and a renewed focus on the core principles of decentralization and auditability to build a more resilient and trustworthy DeFi ecosystem.