Aave Faces Potential Losses of Up to $230 Million Following Kelp DAO Bridge Exploit

A recent exploit of the Kelp DAO and LayerZero bridge has put lending protocol Aave at risk of losing up to $230 million, depending on the resolution of the situation. According to a report published by Aave Labs and LlamaRisk on the Aave governance forum, the incident revolves around rsETH, a liquid restaking token issued by KelpDAO. The protocol uses a bridge mechanism to transfer rsETH between blockchains, locking tokens on one chain and issuing corresponding copies on another. An attacker exploited this setup by creating a forged transfer message that appeared legitimate, resulting in the system approving the transfer despite the tokens never leaving the sending chain. This led to the creation of new tokens without backing, with 116,500 rsETH being released from the Ethereum-side bridge. Instead of selling the assets on the open market, the attacker deposited 89,567 rsETH into Aave as collateral and borrowed approximately $190 million in ETH and related assets across Ethereum and Arbitrum. Aave Labs quickly responded by freezing rsETH markets, setting loan-to-value ratios to zero, and halting new borrowing against the asset. The outcome now largely depends on how Kelp handles the shortfall. If losses are spread across all rsETH holders, the token would experience an estimated 15% depegging, resulting in around $124 million in bad debt for Aave. However, if losses are isolated to Layer 2 networks, the impact would be more severe, with bad debt rising to approximately $230 million and concentrated on networks such as Arbitrum and Mantle. The exploit stemmed from weaknesses in Kelp's verification of cross-chain messages using LayerZero. By manipulating this process, the attacker was able to make certain assets appear fully backed when they were not, allowing them to extract value from the system. The incident has raised concerns about the potential for undercollateralized loans and has led to a significant withdrawal of around $6 billion in total value locked from Aave. The report highlights Aave's indirect exposure to external systems and the need for ecosystem participants to address potential losses. Discussions are underway to address the potential losses, with Kelp's DAO treasury holding approximately $181 million in assets.