The butterfly effect of Balancer's theft: Why did XUSD decouple?

Original Author: Omer Goldberg, Chaos Labs
Original Compilation: Deep Tide TechFlow

Summary

Hours after the multi-chain platform @Balancer faced a vulnerability attack that triggered widespread uncertainty in the DeFi space, @berachain executed an emergency hard fork, and @SonicLabs froze the attackers' wallets.

Subsequently, the price of Stream Finance's xUSD stablecoin significantly deviated from its target range, exhibiting a clear decoupling phenomenon.

Long-term Issues Resurface

The long-standing controversies surrounding leverage operations, oracle construction, and proof of reserve (PoR) transparency have once again come to the forefront.

This is a typical case of a "reflexive pressure event" outlined in our article "The Black Box/Vault of DeFi" last Friday.

What Happened? / Background

The Balancer v2 vulnerability erupted across multiple chains, and for quite some time, it was unclear which liquidity pools were affected and which networks or integrated protocols were directly exposed to risk.

Capital Panic in an Information Vacuum

In an information vacuum, the reaction of capital is as predictable as ever: depositors rush to withdraw liquidity from any source they believe may be directly or indirectly affected, including Stream Finance.

Controversy Over Lack of Transparency

Stream Finance currently does not maintain a comprehensive transparency dashboard or proof of reserve; however, it provides a link to Debank Bundle to display its on-chain positions.

Nevertheless, after the vulnerability outbreak, these simple disclosures failed to clearly address the issue of risk exposure: the price of xUSD (Stream's yield-generating dollar product) dropped from the target price of $1.26 to $1.15, and has now rebounded to $1.20, while users report that withdrawals have been suspended.

Risks and Controversies of Stream Finance

Stream is an on-chain capital allocation platform that operates high-return, high-risk investment strategies using user funds.

The construction of its portfolio employs significant leverage, making the system more resilient under stress. However, the protocol has recently come under public scrutiny due to controversies surrounding recursive loops/minting mechanisms.

While the current situation does not directly indicate a liquidity crisis, it reveals the market's high sensitivity. When negative news emerges and confidence is questioned, the shift from "possibly no problem" to "redeem immediately" can often be very rapid.

xUSD is used as collateral and is distributed across multiple chains in Curated Markets, including Euler, Morpho, and Silo, covering ecosystems such as Plasma, Arbitrum, and Plume.

The protocol itself has significant risk exposure in these markets, with the largest being $84 million USDT borrowed against xUSD on Plasma.

Collateral Mechanism and Risk Buffer

When the market price of xUSD falls below its book value, the related positions are not immediately liquidated. This is because many markets do not tie the value of collateral to the spot AMM (automated market maker) price but instead rely on hard-coded or "fundamental value" feeds, which track reported asset support rather than current secondary market prices.

In calm periods, this design can mitigate tail risk liquidations caused by short-term volatility, especially in stable products. This is also one reason why DeFi protocols performed better than centralized platforms during the liquidation wave on October 10.

However, this design can also quickly turn price discovery into trust discovery: choosing fundamental (or hard-coded) oracles requires thorough due diligence, including the authenticity, stability, and risk characteristics of the asset support.

In short, this mechanism is only applicable when there is comprehensive proof of reserve and the ability to complete redemptions within a reasonable time. Otherwise, the risk is that lenders or depositors may ultimately bear the consequences of bad debts.

Stress Testing on Arbitrum

Taking Arbitrum as an example, the current market price of the MEV Capital Curated xUSD Morpho Market has fallen below the LLTV (Lowest Loan-to-Value). If the pegged price of xUSD cannot recover, the market may further deteriorate with utilization reaching 100% and borrowing rates soaring to 88%.

We do not oppose fundamental oracles; on the contrary, they play a decisive role in preventing unfair liquidations caused by short-term volatility. Similarly, we do not oppose tokenized or even centralized yield-bearing assets. But we advocate that when deploying money markets around these assets, basic transparency must be achieved, and modern, systematic, and professional risk management must be adopted.

Curated Markets can become engines of responsible growth, but they must not devolve into a race sacrificing safety and rationality in pursuit of high returns.

If a "domino effect" complex structure is built, then one should not be surprised when it collapses at the first gust of wind. As the industry becomes more specialized and some yield products become structured (but potentially more opaque to end users), risk stakeholders must raise their standards.

While we hope to ultimately resolve the issues for affected users, this incident should serve as a wake-up call for the entire industry.

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