BonqDAO’s recent rekt is the newest exploit of a series of messes. Ankr($5M), Lodestar Finance($6.5M), Wormhole ($326M), Mango Markets ($115M bad debt), AAVE’s CRV Short saga ($1.6M bad debt), not to mention the UST-LUNA fiasco leading DeFi from summer to the freezing winter.
In total, hackers stole more than $3.2 billion from decentralized finance protocols in 2022.
These risk events have been cruising the world’s trust and confidence again and again. dlnews.com/articles/defi/defi-hackers-stole-32bn-amid-surge-in-crypto-bridge-hacks-lazarus-group/
We need to measure the risks to minimize them.
To measure DeFi protocols’ risks, EigenPhi proposes a theoretical framework for anticipating and diagnosing DeFi protocols' flaws and risks: The Tokenomic Trilemma.
The trilemma’s key point is: for a crypto token, it’s difficult simultaneously to achieve three conditions of free tradability, anchored price, and independent issuance.
Without acknowledging the Tokenomics Trilemma, DeFi protocols may not place enough value on liquidity data, resulting in an information gap disadvantage against searchers and attackers who are lurking all the time.
Why do Algorithmic Stablecoins always fail? Why have crypto bridges suffered losses of over $1.8 billion? The Tokenomics Trilemma is the hidden force.
A deep dive into the trilemma shows protocols the way out: to mitigate future risks; the industry needs to focus more on liquidity data. We propose that a feedback system based on real-time liquidity sensors is indeed helpful in achieving proactive risk management.
Here are 6 reasons why we need DeFi protocols to be more susceptive to liquidity movements.
1️⃣ The liquidity in DeFi is size-limited and volatile.
2️⃣ The most basic mint(), transfer(), burn(), and more complex business actions such as swap(), borrow(), repay(); these functions ultimately change the liquidity status and the network entropy of protocols.
3️⃣ Liquidity tokens and synthetic tokens are adopted to improve DeFi's capital efficiency and size limit issues. Yet they elevate the entire leverage level of the system.
4️⃣ Some current protocol designs, including algorithmic stablecoins and cross-chain protocols, may be overconfident in challenging the trilemma. We need to be wary of any tokens that claim to be price anchored.
5️⃣The use of smart contracts positions Defi to do this because txs are entirely transparent in both issuance and trading stages, making liquidity calculation in DeFi possible. Simultaneously this also provides the database to design a proactive risk management model.
6️⃣ mint() creates new tokens and liquidity ⬆️. burn() destroys the tokens and liquidity ⬇️. Swapping 2 or more tokens, corresponds to the price discovery. Finally, the lending process increases leverage. These are fundamental points at which we measure liquidity.
Whether threats come from manipulating price oracles or stealing private keys to directly withdraw funds, monitoring early liquidity anomalies data remains a much-needed risk control tool to assist in the discovery of attacks.
Wanna learn more? 👉 The Tokenomic Trilemma: A Theoretical Basis for Anticipating Protocols' Design Flaws eigenphi.io/report/the-tokenomic-trilemma