The Decentralized Financial Crisis

Abstract

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.

BLOCKEYE: Hunting for DeFi Attacks on Blockchain

“…Security of DeFi projects is relatively less discussed in previous works. Several mathematical and economic models were proposed to help understand risks of DeFi in a theoretical manner [11], [12], [13], [14].…”

Decentralized Governance of Stablecoins with Closed Form Valuation

“…We now introduce a governance attack vector, as per [6]. A rational adversary exists, who only engages in an attack if the attack profits exceed costs.…”

“…This may not require 50% of GOV tokens as governance participation is commonly low. Neither does it require a single wealthy adversary, since many attackers can collude via a crowdfunding strategy (e.g., [3]), or a single attacker could borrow the required tokens via a flash loan (as in [20,6]). 3 Formally, we consider an adversarial agent with a ζ fraction of GOV tokens, who is able to steal a γ fraction of collateral in the system.…”

“…Control is often placed in the hands of a cooperative of governance token holders who govern the system. This cooperative, however, is known to face perverse incentives, both theoretically (e.g., [7,20,6]) and often in practice (e.g., [5,18]) to steal (or otherwise extract) value.…”

Stablecoins 2.0: Economic Foundations and Risk-based Models

“…4.1.2 Problem 2: Capital structure with governance attack. We consider a governance attack vector of the form described in [94] and [42]. In such an attack, an agent with a ζ fraction of GOV tokens is able to steal γ fraction of collateral in the system.…”