Curve Exploit: Curve Founder Michael Egorov’s Loan Positions At Risk?

This explainer will cover:

• The risky loans at stake.
• The attempts to prevent liquidation.
• Contagion risks and the outlook for DeFi.

Egorov's Risky Loans

Curve Finance founder Egorov has taken full advantage of the fact that the CRV governance token is accepted as collateral across different DeFi protocols. He collateralized 460M CRV to take out $110M in stablecoin loans. However, the 460M CRV represents 47% of the total supply, resulting in a systemic risk if the loan were ever to be liquidated.

Egorov’s loans spread across a $63M loan from Aave, collateralized by 34% of the CRV supply.

This loan is at risk of being liquidated, with a liquidation price of 0.3767 CRV/USDT.

An even bigger risk is Egorov’s loan from Fraxlend worth $19.5 million. Due to the particular interest rate mechanism of Fraxlend, the APY on the loan doubles every 12 hours. The interest rate is already extremely high at over 80% APY and could reach 10,000% APY within a few days.

Egorov's loans across protocols are risky on two fronts - the possibility of CRV price decline triggering liquidations across the board, and the runaway interest rate on the Fraxlend loan increasing liquidation risk regardless of price action. Both scenarios could force the sale of a substantial portion of the CRV supply.

Contagion Risks

If Egorov's loans are liquidated, it risks triggering a cascading crisis across multiple protocols in DeFi. Several platforms accept CRV as collateral, including Aave, Abracadabra, Fraxlend, Inverse Finance and Silo Finance.

A collapse in CRV price would likely force these protocols to begin liquidating the CRV collateral backing loans on their platforms. However, with minimal liquidity, these mass liquidations could rapidly wipe out the CRV value.

Protocols forced to liquidate CRV collateral at fire sale prices would likely have to absorb substantial bad debt. Those that isolated risk, like Fraxlend and Aave V3, would see losses contained to CRV lenders.

But losses may spread more widely from protocols like Aave V2 that didn't isolate risk. There is also exposure for stablecoins like Abracadabra's MIM that hold CRV in collateral baskets.

This interdependent web of CRV collateral creates uncertainty around how losses might cascade across DeFi in a crisis scenario. But it's clear the ripple effects could spread far beyond Curve itself.

Attempts To Reduce Risk

Egorov has taken some steps to try and reduce the liquidation risks facing his loans. He has made multiple repayments on his Fraxlend debt, paying back around $4 million so far.

The goal is to reduce the loan utilization rate and thus cause the exponential interest rate growth to decelerate. However, as soon as he repays debt, lenders have been quick to withdraw liquidity, keeping utilization elevated.

Egorov has also deployed a new Curve pool offering incentives for providing liquidity to the high-risk Fraxlend CRV/FRAX pool he borrowed from. The aim is to incentivize more stablecoin liquidity to reduce utilization rates. But not everyone is impressed by Egorov’s strategy to mitigate the crisis:

In the first 4 hours, this attracted around $2 million in liquidity and dropped Fraxlend utilization to 89%. However, rates remain dangerously high.

While Egorov is attempting to stabilize his debt positions, the ability to meaningfully reduce liquidation risks appears limited so long as lenders remain skeptical and pull funds quickly.

Outlook

Lenders are wary of keeping funds in pools with his risky CRV collateral, withdrawing quickly when they get the chance. This makes it challenging to substantially improve utilization rates or interest rates, especially since only $10M worth of CRV on-chain liquidity are available.

Exponential interest rate growth means loans like that from Fraxlend face imminent risk of margin calls. A liquidation cascade could spread losses and contagion across protocols like Aave, Abracadabra, and others using CRV as collateral.

Given the scale of Egorov's collateral across DeFi, a liquidation cascade could have severe repercussions. Investors may want to reduce exposure to CRV and related governance tokens in the near-term.

Protocols reliant on CRV face a nervous wait to see if disaster can be averted. At the time of writing, speculation abounds on Crypto Twitter that Egorov may find a buyer for his CRV in an OTC transaction:

Most recently, Egorov sent 10M CRV, worth $5.9M, to a new wallet and received $5M USDT from 4 addresses. This could potentially be an OTC deal at $0.40 per CRV.

All eyes will remain on Egorov's high-stakes balancing act and whether he can successfully pull back from the brink of liquidation.