(In)Stability for the Blockchain: Deleveraging Spirals and Stablecoin Attacks

Klages‐Mundt, Ariah; Minca, Andreea

doi:10.48550/arxiv.1906.02152

Cited by 9 publications

(22 citation statements)

References 7 publications

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“…Deleveraging spirals and pegged assets. A series of fundamental results in relation to the ability of noncustodial stablecoins to maintain their peg is provided in [40]. It is shown that stablecoins face deleveraging spirals which cause illiquidity during crises, and that stablecoins have 'stable' and 'unstable' domains.…”

Section: Related Workmentioning

confidence: 99%

The Decentralized Financial Crisis

Gudgeon¹,

Perez²,

Harz³

et al. 2020

Preprint

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The Global Financial Crisis of 2008, caused by excessive financial risk, inspired Nakamoto to create Bitcoin. Now, more than ten years later, Decentralized Finance (DeFi), a peer-to-peer financial paradigm which leverages blockchain-based smart contracts to ensure its integrity and security, contains over 1bn USD of capital as of February 2020. Yet as this ecosystem develops, with protocols intertwining and the complexity of financial products increasing, it is at risk of the very sort of financial meltdown it is supposed to be preventing.In this paper we explore how design weaknesses in DeFi protocols could lead to a DeFi crisis. First, overcollateralized DeFi protocols are vulnerable to exogenous price shocks. We quantify the robustness of DeFi lending protocols in the presence of significant falls in the value of the assets these protocols are based on, showing for a range of parameters the speed at which a DeFi protocol would become undercollateralized. Second, we present a governance attack on Maker-the largest DeFi protocol by market share-that allows an attacker to steal all 0.5bn USD worth of collateral. Moreover, we present a novel strategy that would allow an attacker to steal the Maker collateral within just two transactions and without the need to lock any tokens. This paper shows that with the composition of collateralized debt in these DeFi protocols, the failure of one protocol may lead to financial contagion, resulting in losses ranging from 145m USD to in excess of 246m USD.

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Section: Related Workmentioning

confidence: 99%

The Decentralized Financial Crisis

Gudgeon¹,

Perez²,

Harz³

et al. 2020

Preprint

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“…Given the vulnerability of PoS to cartel-like behavior that can be coordinated via an external market, one might naturally ask if there are also any endogenous financial risks on PoS protocols that support smart contracts. Recently, there has been an uptick in interest in Decentralized Finance ('DeFi'), which uses smart contracts to implement standard financial primitives in a purely on-chain manner [29]. These primitives, such as exchanges [54], lending [33], and stable reserve currencies [25,2,36], decentralize banking functions by creating incentives that encourage rational participants to receive arbitrage profits for maintaining the system's security, while also meting out financial punishments for misbehavior.…”

Section: Transitioning Security From Pow To Posmentioning

confidence: 99%

Competitive equilibria between staking and on-chain lending

Chitra¹

2020

Preprint

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Proof of Stake (PoS) is a burgeoning Sybil resistance mechanism that aims to have a digital asset ("token") serve as security collateral in crypto networks. However, PoS has so far eluded a comprehensive threat model that encompasses both Byzantine attacks from distributed systems and financial attacks that arise from the dual usage of the token as a means of payment and a Sybil resistance mechanism. In particular, the existence of derivatives markets makes malicious coordination among validators easier to execute than in Proof of Work systems. We demonstrate that it is also possible for on-chain lending smart contracts to cannibalize network security in PoS systems. When the yield provided by these contracts is more attractive than the inflation rate provided from staking, stakers will tend to remove their staked tokens and lend them out, thus reducing network security. In this paper, we provide a simple stochastic model that describes how rational validators with varying risk preferences react to changes in staking and lending returns. For a particular configuration of this model, we provide a formal proof of a phase transition between equilibria in which tokens are predominantly staked and those in which they are predominantly lent. We further validate this emergent adversarial behavior (e.g. reduced staked token supply) with agent-based simulations that sample transitions under more realistic conditions. Our results illustrate that rational, non-adversarial actors can dramatically reduce PoS network security if block rewards are not calibrated appropriately above the expected yields of on-chain lending.

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“…However, we do not solve the stated open problems in the context of this paper. This work builds on the previous attacks on decentralized stablecoins identified in [50].…”

Section: Introductionmentioning

confidence: 96%

“…We uncover five central dimensions of risks. In non-custodial stablecoins: (1) effects from deleveraging-like processes on collaterallike assets and risk in underlying collateral-like thing (as discussed, e.g., in [50,51]), (2) data feed and governance risks, (3) base layer risks from mining incentives, and (4) smart contract coding risks, on which the formal verification literature can be applied. In contrast, in custodial stablecoins, the first applies in a very different way to affect issuer incentives as well as an additional central risk dimension of (5) censorship and counterparty risk.…”

Section: Introductionmentioning

confidence: 99%

Stablecoins 2.0: Economic Foundations and Risk-based Models

Klages-Mundt,

Harz,

Gudgeon

et al. 2020

Preprint

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Stablecoins are one of the most widely capitalized type of cryptocurrency. However, their risks vary significantly according to their design and are often poorly understood. In this paper, we seek to provide a sound foundation for stablecoin theory, with a risk-based functional characterization of the economic structure of stablecoins. First, we match existing economic models to the disparate set of custodial systems. Next, we characterize the unique risks that emerge in non-custodial stablecoins and develop a model framework that unifies existing models from economics and computer science. We further discuss how this modeling framework is applicable to a wide array of cryptoeconomic systems, including cross-chain protocols, collateralized lending, and decentralized exchanges. These unique risks yield unanswered research questions that will form the crux of research in decentralized finance going forward.

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(In)Stability for the Blockchain: Deleveraging Spirals and Stablecoin Attacks

Cited by 9 publications

References 7 publications

The Decentralized Financial Crisis

The Decentralized Financial Crisis

Competitive equilibria between staking and on-chain lending

Stablecoins 2.0: Economic Foundations and Risk-based Models

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