Last weekend, the biggest story, or accident, that happened in the on-chain world was the dYdX “attack”.
YFI recorded a drop of about 45% in one day. The plunge affected the long positions on dYdX, causing a chain of liquidations on dYdX, with nearly $38 million in funds being liquidated.
Due to the extremely rapid speed of this decline, a funding gap occurred at one point, and dYdX paid a price of 9 million US dollars.
After this incident, various parties including dYdX and the community had different reactions.
Odaily Planet Daily sorted out 6 key issues surrounding this incident.
How do market fluctuations occur?
dYdX market data shows that YFI has continued to rise since the beginning of this month. Before this incident, the price of YFI had already achieved an increase of more than 200% in this round of increase.
On November 18, Yearn.finance (YFI) took an unexpected turn. YFI’s price fell 45% in a matter of hours, from $14,500 to $8,300, swallowing up recent gains. More than $250 million in market value evaporated, with the market cap falling from $525 million to $275 million.
During this drastic decline, dYdX’s user positions also suffered huge serial liquidations.
On-chain data shows that nearly half of the total supply of YFI is stored in 10 wallets. Therefore, some people believe that this plunge was manipulated by insiders.
Lookonchain monitoring shows that an anonymous user deposited a large amount of USDC into dydx through multiple addresses, suspected of making long operations on YFI. When the price of YFI reached its highest point on November 17, it is speculated that this user may have closed his long position and opened a short position. This speculation is supported by the fact that the user withdrew a large amount of profit from dydx after the price crash on the 18th.
Previously, on November 1, the price of SUSHI fluctuated violently, and this anonymous user used the same method to try to make a profit by manipulating the price of SUSHI.
Data platform Arkham said that YFI's trading volume on dYdX is usually very low. This also shows that the liquidity of the token is not sufficient, and the price is easily manipulated in the face of a large amount of funds.
How did the $9 million liquidation gap arise?
As we all know, when a user performs a "buy/sell" operation, there must be a counterparty that performs a "sell/buy" operation in the opposite direction. "Liquidation" is a trading operation that is enforced by the system, and naturally follows the logic of ordinary transactions.
When the market is in a fast-changing extreme situation, the "sell/buy" of the liquidation may face a sudden drain of liquidity and lack of sufficient counterparty. Imagine that if a target falls to $100, the position held by the user needs to be sold at the current price to successfully offset the account, but before the selling action is completed, the price has continued to fall to $90. At this time, the net asset value held by the user becomes negative.
Previously, the Mango attack incident reported by Odaily Planet Daily was similar to this.
"Attack" or "Transaction"?
After the dYdX liquidation occurred, dYdX founder Antonio Juliano posted on social media that the YFI open interest on dYdX soared from US$800,000 to US$67 million within a few days. Before the YFI price plummeted, dYdX had increased the initial margin ratio of YFI, but this failed to prevent the incident from happening.
Antonio noted that this was clearly a "targeted attack" on dYdX, including market manipulation of YFI as a whole. He also said that in response to these incidents, dYdX will work with multiple entities to conduct a comprehensive investigation to uncover the details of the alleged attack. The goal is to maintain transparency with the community in terms of the results of the investigation.
Interestingly, is it reasonable to define this behavior as an "attack"? Similar to the discussion after the Mango hacker attack, there is a view in the community that trading behavior from the open market does not necessarily seem to be defined as an attack.
For the "attackers", this behavior can undoubtedly be called "market manipulation". However, in the absence of technical "hacking" behaviors such as system intrusion, vulnerability exploitation, and private key theft, whether this alternative "manipulation" method can be called an "attack" is controversial.
How does the dYdX Insurance Fund work?
After this incident, a key point discussed by the community was whether the use of the insurance fund was reasonable.
The official dYdX document shows that if a user account is "insolvent", such accounts must be processed immediately to ensure the solvency of the entire system. And the user balance is already negative, how can it pay for the loss? Therefore, the insurance fund becomes the backing for liquidation in extreme cases.
The existence of the insurance fund maintains the solvency of the system. When an account is about to be liquidated, the insurance fund will bear the loss. In the official document, dYdX also gave a clear explanation for this: the insurance fund is not decentralized, and the dYdX team will be directly responsible for the recharge and withdrawal of funds.
The team also said that it may be possible to decentralize certain aspects of the fund in the future, but in the initial stages, the priority is to ensure that insolvent accounts are dealt with in a timely manner.
What happens if the insurance fund is depleted?
Currently, official data from dYdX shows that after the payment of approximately US$9 million in the insurance fund, there is still US$13.86 million left in the insurance fund, which is only enough to withstand about one more incident of the same level as the "YFI incident".
If the insurance fund is depleted, the most profitable and leveraged positions can be used to offset negative balance accounts to maintain system stability. Deleveraging is a socialized loss mechanism that requires profitable traders to contribute part of their profits to offset insolvent accounts.
After deleveraging occurs, the accounts with the highest leverage will be deleveraged first. Specifically, the platform will automatically force a portion of traders to reduce their positions, giving priority to accounts with high profits and high leverage combinations, and using their profits to offset insolvent accounts.
Given the significant impact that deleveraging has on users, deleveraging is only used when the insurance fund has been exhausted.
Who is the next dYdX?
dYdY’s public statement on this incident stated that “dYdX now bans high-profit trading strategies.”
What is a “high-profit trading strategy”?
This term comes from the famous $116 million attack on Mango Markets in 2022. The initiator of this attack, Avraham Eisenberg, called his "manipulation of spot market prices + high leverage profit in the contract market" model a trading strategy. He believes that all his actions in the open market are legal and do not constitute an "attack."
Although this incident caused a stir last year, did it really teach the industry a lesson?
When discussing the issues of decentralized derivatives trading platforms, we have to face a reality that cannot be ignored: the lack of liquidity. As recently demonstrated on the dYdX platform, the combination of price manipulation and insufficient liquidity has become a dangerous and recurring pattern. This not only reflects the inherent challenges of decentralized platforms, but also exposes the fragility of the cryptocurrency market.
After the incident, the founder of dYdX launched a series of updates about dYdX, including: market updates will become easier, making it easier for the market to generate higher liquidity; the maintenance margin function will become updateable (previously not supported in V3); the maintenance margin function will be able to change with the position size (previously not supported in V3); the liquidation engine will be redesigned. ; No withdrawal requests with any negative assets will be accepted (until the relevant positions are liquidated).
Although a series of measures have brought new changes to dYdX, is this the end of such incidents?
The Mango incident shows that when a token with insufficient liquidity appears, it does not seem difficult to manipulate the spot price of a token. The various consequences presented by the dYdX incident are just a "recurrence" of the previous incident.
Last time it was Mango, this time it was dYdX, but this pattern is likely to repeat itself on other platforms, each time leaving a profound lesson for the entire industry. The lack of liquidity has brought too many bad consequences to the crypto industry. This recurring problem reminds us that the crypto ecosystem is far from mature, and both investors and developers must adopt a more cautious strategy. Only through the collective efforts of the industry and continued innovation can we truly realize the potential of DeFi while minimizing its risks.
