The Recent $350 Million DeFi Liquidation May Support Controlled Auctions Versus Getting “Rekt”

It was widely reported that cryptocurrency investors lost more than $350 million earlier this week as they closed out leveraged positions on various decentralized finance (DeFi) exchanges after the price of Ethereum (ETH) dropped to as low as $2,190.

Although Ethereum’s price had returned to above $2,400 at press time, the domino effect of price damage had been done, according to CoinGecko.com. Hundreds of investors had been liquidated or “rekt” — short for crypto, wrecked — and the total value locked across all DeFi platforms had fallen by almost 30% in the space of a week.

How AAVE Became a Loser… But More of a Winner

During the chaotic sell-off, crypto DeFi token Aave (AAVE) reportedly lost almost 24% of its market value. And yet, since Aave is a preferred DeFi lending platform for many investors looking to borrow money to increase their investment amounts, Aave made more than $6 million in a single night by closing and selling collateral from investors who lost their respective bets.

Aave founder Stani Kulechov told his 248,000+ followers on X (formerly Twitter) that this was a significant win for his protocol and DeFi in general.

The Aave Protocol has withstood market stress across 14 active markets across various L1s and L2s and has captured $21 billion in value.

Aave Treasury generated $6 million in revenue overnight from decentralized liquidations for keeping markets secure.

While the crypto space has avoided an industry-wide crash, DeFi has also delayed its own crash, but critics argue that DeFi has systemic issues that prevent it from outperforming.

Is Regulation the Only Way to Fix DeFi?

A recent whitepaper by the folks at KPMG titled DeFi and the Illusion of Decentralization states that the DeFi ecosystem is built almost exclusively on the Ethereum blockchain. It comes as no surprise to anyone that the ETH blockchain operates on a PoS consensus model that allows its validators to decide which transactions to execute and when; the authors argue that it is not truly decentralized.

The article also criticizes the lack of transparency in the DeFi liquidation process in general, high collateral requirements for leverage, often up to 100% of the loan amount, and a system that supports advanced trading bots that beat average investors with trading executions that occur in milliseconds.

The whitepaper concludes that the only solution to improving DeFi is through regulatory safeguards that protect investors. But that is not the only solution.

Controlled Auction for Liquidation Accounts

An alternative option to rethink some of the issues facing the current status quo of DeFi, while avoiding heavy over-regulation, can be found in controlled auctions. Currently, this particular option only appears to be available on Pyth Network via the Express Relay feature.

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Express Relay is an oracle-independent program capable of auctioning valuable transactions (e.g. liquidations) to a network of top prospectors on a given platform or exchange. The auction model eliminates interference from network miners or validators while ensuring access to a highly competitive pricing process.

Benefits of Controlled Liquidation

Hypothetically speaking, the recent $350 million DeFi crash would have played out quite differently. Here’s how the automated auction process would have shaken up if Aave had been running Express Relay during the sale when leveraged accounts were being forcibly closed:

Parties interested in distressed assets will submit their offers and terms to Aave, such as liquidation price, payment speed, and transaction fees.

Aave would then select the winner using a predefined criteria grid to eliminate guesswork and ensure transaction speed. The grid would take into account variables like the highest bid, fastest execution time, or lowest liquidation price.

On paper, a controlled auction avoids the chaotic chaos typically associated with a market liquidation event. It also addresses a handful of inefficiencies that would be unavoidable under the typical liquidation model, notably:

Moderated auctions aren’t a cure-all for DeFi’s problems, but they do represent a step forward in a critically important area where DeFi has clear room for improvement. Innovations like these are further evidence that DeFi isn’t just replicating traditional finance on the blockchain, but charting a new path toward a more equitable and efficient financial system.