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All right, everyone. Welcome back to Empire. We've been talking about Kelp and Aave, and all the craziness that's unfolded over the last two weeks. DeFi United, the bailout, whatever you want to call it. And yeah, I've been talking to Stani on the side and, you know, Mike, obviously, EtherFi stepped up in a huge way. So, decided to bring them both on the podcast. We've got Mike who's the CEO and co-founder of EtherFi as well as Stani who many of you already know. I'm sure he's been on the podcast many times, but you know, founder of Aave. Mike, welcome guys.
Yeah. How much sleep have we gotten collectively in the last two weeks?
More in the last few days. I think it seems like the worst is over and the ecosystem kind of pulled through. So it's been better in the last little while, but yeah, it was an intense week for sure.
Yeah, I think the first day out of the bridge exploit, like the first few days was probably the most difficult. You know, couldn't really sleep much for various reasons, but also because we're sort of against the time. Obviously now it's a little bit more easier, but there's still a good amount of work to do. So yeah, it's running still low.
Yeah. The thing that surprised me, I guess, and bothered me is at least to me, it was so obvious immediately within a matter of hours that this was an existential threat to DeFi. Like it was just the sort of like step one, two, three, four, I was like, 'All right, game over.' Like this is it. And so it was so clear that like, okay, people needed to spring into action immediately, start addressing this thing or else it was going to spiral. And I think in fact if it wasn't for the work that Stani and his team and you know some others have done that was the default path. I don't think people recognize that just without that intervention, without that effort that people put in, the default path was just a complete blow up of DeFi.
Yeah, I think not everyone really understood sort of like where we were at that point in the space because effectively this wasn't about Aave, it was about DeFi as an ecosystem overall and how to manage this sort of like big capital movements that are done also quite programmatically. And I think that the protocols involved and the teams involved typically are really diligent. We work with them on a day-to-day basis. But when something like this happens where you sort of have a remote dependency where things happen and it creates an attack vector and affects the whole space. That's sort of where everyone needs to sort of move and figure out what are actually the next steps because that's the first thing to figure out. And I think to Mike's credit, Mike was there at the very beginning and realized sort of like what are the potential paths that things could go, including the extreme worst case scenarios. He realized how important this is for DeFi and that wasn't the case for everyone to understand at the first glance, but it sort of helped quite a lot during the process.
Yeah. Mike, can you maybe walk us through why this was such... I'm reading your tweet here. It says, you know, FTX, he said, you know, we committed 5K ETH to the Kelp hack recovery fund because we thought there was a real risk that this could have killed DeFi. FTX would have looked small in comparison. I'm not sure if that's just a bold statement to get your tweet, you know, more viral or if that's like if you genuinely believe that, but if you I'd really love to hear the thought process behind it.
Yeah, you know, it's pretty straightforward, honestly, and I 100% stand by that. You know, I'm sure lots of people have read about kind of the high level events that took place but the basic idea is, you know, Kelp had a certain structure to their cross-chain, their bridging setup. They of course were using LayerZero but they had a certain structure they decided on and that was exploited by, you know, DPRK, North Korean hackers. And so the direct impact was about 200 some million dollars that were stolen. But what it meant and the default path for teams when something like this happened is to sort of pull back, lawyer up, get super defensive. And that's what was happening. You know, it's hard to fault a team for doing that, right? You're in this extreme situation. You don't know what to do. Most people haven't lost $200 million before. So, you don't know what you would do if you were placed in that spot. So, the default is all right, lawyer up, pull back. Okay, what's the safest thing that you can do? Well, the safest thing you can do is declare bankruptcy. Say, all right, this wasn't our fault. We're now encumbered, bankruptcy. Now, if that happens, if they had chosen to go down that path, which I think, I don't want to speak out of turn, but I think their counsel was advising them very strongly to do this, then it's not a $200 million problem anymore. Now it's a billion and a half dollars because there was a billion and a half dollars of rsETH sitting out there and if Kelp had gone into bankruptcy that's, you know, that's now locked up, that $1.5 billion isn't moving anywhere for probably years as we've seen how long these things take to play out. So now you have a billion and a half dollars that's stuck in DeFi. A lot of it in Aave markets but also on Compound and Euler and a lot of other protocols. Every one of those protocols frankly is now because now you have a billion and a half dollars of assets that aren't going to move. So there's going to be at least a liquidity crunch because you won't be able to pull them out for years which then would have had a cascade effect on the lending protocols. Every CeFi exchange has assets in various lending protocols. Tons of every DeFi protocol has assets in Aave and everybody else. So this is something that it wasn't just going to impact Kelp. It was going to impact everybody. So that was what to me seemed like a clear Armageddon scenario. And again everyone's default path was sort of to pull back, lawyer up and throw their hands up. And so what I said again to repeat was the one team that really just stood up and said, 'No, we're going to fix this. Let's raise a recovery fund. Let's actually make sure that this blow up doesn't happen.' Was Aave. They just took the responsibility. In many ways, this was out of all, you know, plenty of blame to go around, but out of all the parties, they were the least responsible, right? But they just took ownership and really ran with it. So that was great to see and I think in the end all the work combined ended up averting that disaster scenario.
Yeah, if you think about it like from the asset perspective, the asset itself is basically backed on mainnet. So sort of like most of the backing is there and obviously the effect is more on L2s and the kind of challenge is what basically Mike said is that if you choose the sort of like a strategy path of like everyone just lifts their hands up and basically takes protective measures, nothing here can be actually solved. And we saw a lot of that and we saw a lot of sort of like a direction going towards that. And from a perspective, one path for us would have been to just focus on okay how do we solve this for Aave, how do we apply a haircut and call it a day and continue business as usual and register the deficit and pay that to the protocol treasury and balance sheet and revenue and move onwards and sort of like write it off and make the protocol whole. And what we realized is that there was so many stakeholders involved in this incident and protocols, LPs, different teams, cascading effects and whatnot. So we realized that actually if we really want to get everyone onto the same table, we need to find a sort of a conclusion that really satisfies everyone. And that is basically to go as whole as possible and find the means of doing that and figuring out how everyone can actually contribute in the most responsible way into this. And that is what sort of the big difference here and why DeFi United was born is because it wasn't about how do we sort of write this off on Aave but how do we make this whole ecosystem whole and restore the confidence and that confidence restoring is far more greater than any sort of individual protocol impact. And I think where Mike and EtherFi played a huge role is that they were sort of like mediating and getting everyone on the table, pushing any sort of lawyers out of the table. These people don't belong into Web3 and things need to be solved between founders and teams natively. And to Mike's and their team's credit they were the ones that actually were taking a lot of sort of putting on the table ideas that you know you necessarily won't do that from a perspective of like why would you come and help other protocols and even sort of like in the same landscape where they offer similar products and doing that for the sake of restoring the whole confidence in the space and that is very rare. I don't think that is even sort of like a solution that people think more in the traditional finance. And once this whole DeFi United started to actually kick in and we saw the support, it sort of changed the whole narrative from like oh these teams are just pointing fingers at each other into like okay let's all come together and really sort of like restore, I won't call it like a rescue or any sort of like a bailout because bailout is forced obviously by taxpayers and whatnot. This was more of like hey we all have skin in the game we all believe in the space and we sort of like everyone is improving their security but we need to act now and for that we restore the confidence.
Yeah Stani, you said, I saw one of your tweets you said it was the hardest couple of weeks that you experienced in your entire life. Was there a moment in time that you maybe in day one or day two of this unfolding that you thought, you know, maybe this is the thing that kills Aave?
I wasn't thinking about Aave to be honest. I was thinking more about DeFi and what are the consequences of DeFi because I do think that Aave is sort of built to be resilient. Like when you think about protocol building, you optimize for that sort of like not the 99% that works but let's say 0.01%, 0.1% that things do not work and how do you reestablish the resiliance basically. And we've obviously seen multiple market and credit cycles from like the Terra/Luna, the FTX and even in the early days of DeFi like Black Thursdays and Mondays and whatever there was but it sort of shows the resilience. And for me what was more important was to understand what's actually we have to do to ensure that people have confidence in DeFi because we don't just work on smart contracts but we do a lot of policy work, we do a lot of work with institutions and actually institutions were the most supportive. Like we got a lot of emails from stratified institutions that were offering help and trying to figure out how to progress because they have so much belief in the technology even though we have more skin in the game. So that was really surprising. So I was more worried about how this affects DeFi than anything else. And I think we felt really lonely until a lot of the other sort of like stakeholders like Mike and their team came up and sort of were like putting solutions on the table because that was like a very difficult place to be in. And you're so limited by time constraints, resources, and I think even DeFi United could have been done in various different ways. But like when you have to move fast and execute you really just operate on what you can do during that particular day.
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Mike, why, Stani credited you for going above and beyond. Why was this the, I know you said it was, you know, could be FTX level and you know the cascading effect could have been really taking down DeFi, but why can you just walk me through maybe a little more detail of like how DeFi United, why you decided to make this the moment that you guys really stepped up and like how it came to be and even other ideas I'm curious about of like what else were you guys considering solutions?
I'm probably, I don't know exactly how much I can say but I err on the side of transparency. Yeah, we threw in a lot of different ideas. One of the big ones that we were talking about is just EtherFi acquiring Kelp. Basically just taking on the liability like it was, you know, trying to do that in the span of a week is terrifying because you're basically buying a black box and you have no idea what's in there. It could have taken us down as well, but we were willing to do it. Did I think in the end it wasn't the right solution, but we went pretty far.
Did you give them an offer?
Yeah, we went, I mean we were exploring like three or four different things in parallel and this was meaning like legal docs going back and forth. So this was one of the paths that we were going down. I mean the thing we were trying to optimize for was just like how do we as quickly as possible get this sorted. Another thing I think people don't appreciate is just how stupidly lucky we got. I mean ETH has been basically flat for like two weeks like 2300 like on the dot. There would have been a big freaking problem if ETH suddenly dropped by 20%. Which happens like any random Tuesday, right? Iran starts shooting again, ETH drops 20%. The problem suddenly gets a lot bigger especially when you know utilization...
Wait, explain that. Why the problem gets so much bigger then?
Well so in lending markets and I'm sure Stani can comment more on this, right, when the utilization is 100% you can't liquidate. So that could have led to frankly a much worse cascade where you would have had a lot of bad debt in place. So that created this extreme time urgency because we were just like watching this price hoping that it didn't move and we needed to act quickly mostly to restore confidence. Even just making an announcement I think that what we were doing went a long way to give people sort of a feeling of like all right this is going to be taken care of. And as soon as the announcements went out immediately you saw at least the stablecoin markets start kind of cooling off like now there's hundreds of millions of dollars of liquidity available, the ETH market is now cooling off and lots of sort of unwinding taking place. So that's why I think okay we're past kind of the worst case scenario. But yeah, you know, EtherFi was in this unique position I guess in that we actually had no exposure. None of our vaults had any rsETH exposure. Our position even in Aave was such that we were short ETH because like the looping on our vault is such that it uses wrapped ETH. Our asset is our staking asset as collateral and borrows ETH. So even that actually we could easily unwind it without taking any exposure. I mean our total cost for the increased interest rates on the ETH borrows was like something of 400 ETH. So it was not something that was a major issue for us. But what I saw was if DeFi blows up, EtherFi can't exist. So that's why I didn't give a shit about it was is it a competitor? or is it a like it doesn't matter if DeFi blows up, we can't exist. Therefore, like we had to throw everything we have at it. I mean 5,000 ETH for us is not a small amount of capital, but we just felt like we had to throw everything we had at it in order to make sure that everyone pulled together, everyone actually gathered in a room and were talking to each other to solve the problem. So yeah, and as I said, thankfully we got there.
So I also noticed that when EtherFi came out publicly, a lot of the DeFi projects that they didn't have a skin in the game were starting to actually contribute as well, which was really incredible from Frax to other ones. So it started a really genuine movement in understanding like why is this so important and I think it really helped to bring everyone also onto the same team. I think without DeFi United and without basically Mike coming and actually trying to get people to solve this, I think we were in the first days in a really hard situation because in one way you're dealing with raising funds, in one way you're dealing with analyzing what needs to be done for the attacker's position, on the other side you're dealing with the sort of like human relations and then you are dealing with the DAO. So the sort of focus is really difficult to keep engaged. And I think if you believe in DeFi and what it could bring, it's sort of a thing where everyone just comes and steps in on their own will. Obviously there are people who don't want to support and they don't see that as a path forward and that's totally fine but we believe that if this technology and these protocols are going to scale in the future, we have to ensure that basically we have the stability and these markets quite quickly regain. So the challenge with DeFi is that the capital moves extremely quickly and signals move indicate really quickly. So in stratified, you know, there's certain bottlenecks for example for liquidity movements and I think that's something that we have to think about going forward is that if you have a temporary loss of confidence which in a case basically means that there is positions, liquidity available but not at a specific time so you have to wait the confidence to return. And for our surprise it was pretty interesting to see that really quickly you saw stablecoin liquidity come in back and later ETH liquidity and some of the participants that wanted to help they were actually helping by supplying liquidity. So they were like betting on DeFi and betting on Aave and sort of like pushing the confidence that really actually helped and they obviously enjoyed the higher rates than usual.
Yeah. Are there any teams that you want to call out, well I guess there's the good and the bad. So, are there any teams that you think really stepped up that you want to call out or I guess any teams that were frustratingly maybe absent from the conversations?
Maybe I don't know for, maybe in a few months, maybe in a year we can talk about that. But I think yeah...
But shouldn't there be some sort of like, I mean I'm not saying like, you know, for the Game of Thrones watchers like shame, shame, shame but like I feel like if this is a, you know, Mike if you're right if this was an FTX level event like, you know, the people who are so... 40 billion dollars like this... right so it's kind of crazy to me that someone if it really was that scale which I think you're right like shouldn't everyone have stepped up?
There were a lot of people who joined DeFi United. There were a lot more who did not. So...
Yeah, I mean I guess, you know, definitely there were a lot of expletives in the telegram chats, you know, bitching and complaining and so for sure there was frustration that one party or another didn't step up as much as they could have. On the other hand, I guess like I've ran other businesses before at scale. So like I've been in lawsuits. Like to me I'm like okay I know how this works. I kind of have a playbook of how this turns out. So this fear, maybe just some of us are wired differently. There's less of this fear to me, the fear of inaction was much greater than the fear of like just sort of rushing into the unknown and trying to solve the problem whereas maybe some of the other teams that maybe didn't step up or acted too slowly. I think it mainly came out of fear because if you're facing potentially a whole bunch of lawsuits and even criminal liability in some cases, it's very easy to just lock up and freeze in the moment and that's how things get worse, right? Through inaction.
Yeah, I agree. I think there were sort of like at the beginning a lot of selfish behavior all the way to the LP level. And I think once we got past that like fingerpointing because I think everyone published their sort of like reports and whatnot and then at the point when DeFi United was basically launched I think that was the pivotal moment because at that point it was about okay this is not about whose fault this is, who to blame. It's about basically what are the next steps, how to restore, how to mitigate in the future and how to solve this. And I think that's obviously the teams involved including EtherFi and Lido and Ethena and a bunch of other ones has been really helpful and also teams like Mantle and even in Ethereum side like obviously we try to reach out to everyone including Ethereum Foundation and a lot of the sort of Ethereum guardians as well and Joseph Lubin was willing to step in as well and a bunch of other people. So it really showcases that actually there are a lot of good people in our space and willing to really help. What it means for me personally is that at least I know in the future who are the true friends and willing to step in and also it means that how we can be helpful and step in if this happens to someone else and there is cascading effects so how to prevent that. So I think the biggest win here is that people weren't too selfish and trying to protect themselves instead that they turned into a mode where they're trying to figure out how do we solve this on chain within the communities and in a way that really restores everyone's confidence and everyone is happy and the happy path for everyone is 10 times harder than the happy path for EtherFi or happy path for someone else. So there was a lot of work to do there to get to that point and also the DAO coordination was even... I never coordinated with six different DAOs at the same time with proposals and voting and it's been quite an experience.
Well, what happened with Arbitrum? I think that's like you could make probably a movie about this whole insane situation, right? Where Arbitrum, again I'm probably speaking out of turn, but effectively took back the money that North Koreans stole. And then thankfully that was through a process that money is now on its way back to users. So that was a remarkable, I mean that could have been the thing that made things turn out differently, right? If that money wasn't recovered like that 30k ETH made the hole a lot more manageable than without it. So it's yeah it was a pretty wild situation.
Wait, Mike, say one more thing about the Arbitrum situation. Why was it such a movie-like scenario?
Well, I mean so North Koreans stole a bunch of ETH. A bunch of it was sitting on Arbitrum and so Arbitrum took, I don't know the exact details but they took a vote, they took a collective action to basically pull back that ETH. If they hadn't done that, if the North Koreans had pulled the money off of Arbitrum and then started their swaps on Thorchain or whatever channels they're laundering it through, that money would have just been gone and now you have another 30k ETH, you know what, $80 million to fill. Which would have just made it that much more painful.
Yeah. Are we through, I know we're through the worst of it, but are we through the whole situation?
