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

A recent bridge exploit involving Kelp DAO and LayerZero has put Aave, a lending protocol, at risk of incurring losses of up to $230 million, depending on the resolution of the situation. According to a report by Aave Labs and LlamaRisk, the incident revolves around rsETH, a liquid restaking token issued by KelpDAO, which relies on a bridge mechanism to transfer tokens between blockchains. An attacker exploited this setup by creating a forged transfer message, resulting in the creation of new tokens without backing, and releasing 116,500 rsETH from the Ethereum-side bridge. Instead of selling the assets, the attacker used 89,567 rsETH as collateral to borrow approximately $190 million in ETH and related assets across Ethereum and Arbitrum, leaving Aave exposed to potentially impaired collateral. 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, with two possible scenarios: if losses are spread across all rsETH holders, the token may face a 15% depegging, resulting in around $124 million in bad debt for Aave, or if losses are isolated to Layer 2 networks, the impact could be more severe, with bad debt rising to roughly $230 million. The exploit was made possible by weaknesses in Kelp's verification of cross-chain messages using LayerZero, allowing the attacker to manipulate the process and extract value from the system. This incident has raised concerns about the safety of interconnected DeFi infrastructure and the potential for undercollateralized loans, leading to a withdrawal of around $6 billion in total value locked from Aave. The report highlights Aave's indirect exposure to external systems, resulting in increased collateral risk, pressure on lending positions, and a decline in deposits. Discussions are underway with ecosystem participants to address potential losses, with Kelp's DAO treasury holding approximately $181 million in assets.