On-chain wealth management is fraught with danger

Author: Azuma

DeFi is once again at the forefront of the industry.

As the most vibrant narrative in the industry over the past few years, DeFi carries the hope of continuous evolution and expansion of the cryptocurrency sector. Believing in this vision, I have also been deploying over 70% of my stablecoin holdings into various on-chain yield strategies, willing to accept certain risks for potential returns.

However, recent security incidents have triggered a series of events, exposing inherent issues that were previously hidden beneath the surface, and the overall DeFi market is now filled with a sense of danger. As a result, I personally decided last week to withdraw the majority of my on-chain funds.

What exactly happened?

( Part One: Opaque High-Yield Stablecoins

Last week, several security incidents in DeFi drew attention. If the Balancer hack was an isolated incident, then the de-pegging of two so-called yield-bearing stablecoins, Stream Finance (xUSD) and Stable Labs (USDX), revealed deeper underlying problems.

Both xUSD and USDX are packaged as synthetic stablecoins similar to Ethena (USDe), primarily using delta-neutral hedging arbitrage strategies to maintain their pegs and generate yields. Such yield-bearing stablecoins have become popular in this cycle. Since their business models are not overly complex, and with successful cases like USDe, many stablecoins have emerged, experimenting with all sorts of combinations of the letters and the USD abbreviation.

However, the reserves and strategies of many stablecoins, including xUSD and USDX, lack transparency. Despite the high yields attracting significant capital inflows, these stablecoins’ reserve statuses are not clear.

In relatively calm market conditions, these stablecoins could operate normally. But the cryptocurrency market is prone to sudden, large fluctuations. Trading Strategy analysis indicates that the main reason for xUSD’s de-pegging was that Stream Finance’s opaque off-chain trading strategies encountered an automatic deleveraging (ADL) event during the extreme market conditions on October 11, which broke the delta-neutral hedge balance. Stream Finance’s aggressive leverage further amplified the imbalance, ultimately leading to the protocol becoming insolvent and xUSD losing its peg.

Similarly, Stable Labs and USDX likely faced comparable issues. Although their official statements attributed the de-pegging to “market liquidity and liquidation dynamics,” the protocol has not disclosed reserve details or fund flows, and there are suspicions that the founders’ addresses have collateralized USDX and sUSDX on lending platforms, even at interest rates exceeding 100%, refusing to repay. This suggests the situation could be even worse.

The problems with xUSD and USDX expose serious flaws in the emerging stablecoin protocols. Due to a lack of transparency, these protocols operate as black boxes in terms of strategy. Many claim to be delta-neutral models, but their actual positions, leverage, exchange counterparties, and liquidation parameters are not publicly disclosed. External users cannot verify whether they are truly neutral, effectively shifting risk onto users.

A classic scenario of such risk is users depositing mainstream stablecoins like USDT and USDC to mint new stablecoins like xUSD or USDX for high yields. If the protocol fails (whether genuinely or as a show), users become passive victims. Their stablecoins may quickly de-peg in panic selling. The protocol might attempt to use remaining funds for compensation (though retail investors are usually last in line), or simply run away with the remaining assets.

However, condemning all delta-neutral yield-bearing stablecoins as equally risky is unfair. From an industry perspective, exploring diverse yield strategies is meaningful. Protocols like Ethena, which disclose their operations, have their own advantages (though Ethena’s TVL has also shrunk significantly recently). But currently, many undisclosed or insufficiently disclosed protocols may have similar issues as xUSD and USDX. As I write this article, I can only assume some protocols are problematic, but from a safety standpoint, it’s wise to remain cautious.

) Part Two: Lending Protocols and “Curators” (Main Managers)

Some may ask, “I don’t deal with these new stablecoins, so I’m safe.” This leads to the second major risk in DeFi’s systemic phase — modular lending protocols and “Curators” (the community has gradually adopted this translation, so I will continue using it).

In short, professional institutions like Gauntlet, Steakhouse, MEV Capital, and K3 Capital act as Curators, packaging complex yield strategies into user-friendly liquidity pools on protocols like Morpho, Euler, and ListaDAO. Ordinary users can deposit stablecoins like USDT and USDC with a single click to earn high interest. The Curators decide on the specific yield strategies behind the scenes, such as asset weights, risk management, rebalancing cycles, and withdrawal rules.

Because these pools often offer higher yields than traditional lending platforms like Aave, they naturally attract capital. Data from Defillama shows that the total assets in pools managed by these Curators have grown rapidly over the past year, surpassing 10 billion USD at the end of October and early November, and currently stand at around 7.3 billion USD.

Curators earn profits mainly through performance fees and management fees. The larger the pool and the higher the yield, the greater the profit. Since most depositors are indifferent to the Curator’s brand, choosing pools is often based solely on the apparent APY. This makes the pool’s attractiveness directly tied to its strategy returns, which become the key factor in the profitability of the Curator.

Driven by yield and lacking clear accountability, some Curators have increasingly prioritized profits over safety — “the principal is users’, but the profits are ours.” Recent incidents include MEV Capital and Re7 allocating funds into xUSD and USDX, indirectly exposing depositors in protocols like Euler and ListaDAO to risks.

It’s unfair to place all blame on the Curators alone. Many lending protocols also bear responsibility. In this market model, many depositors don’t even understand the role of the Curator; they simply believe they are depositing into a reputable lending protocol to earn interest. In reality, the protocol acts as an endorsement, benefiting from the surge in TVL. It should oversee the Curator’s strategies, but some protocols have failed to do so.

In summary, the classic risk scenario is: users deposit stablecoins into lending pools without knowing that the Curator is actively deploying funds into emerging stablecoins. When these stablecoins collapse, the pool’s strategy fails, and depositors suffer losses indirectly. This can lead to bad debt in the lending protocol itself (though timely liquidation might mitigate this), and in some cases, the protocol’s oracle prices for de-pegged stablecoins are manipulated to avoid liquidation, which can exacerbate the problem. The contagion then spreads through the system, affecting more users.

Why has it come to this?

Looking back at this cycle, the trading side has already become extremely difficult.

Traditional institutions favor only a few major assets; altcoins keep falling without bottoming out; meme markets are rife with insider manipulation and bots; and the October 11 massacre further wiped out retail investors, many of whom suffered losses or were left behind.

In this context, “more predictable” investment strategies have gained larger market share. The milestone breakthroughs in stablecoin legislation and the proliferation of yield-bearing protocols (some arguably not true stablecoins) offering annualized yields of 10-50% have attracted retail capital. While some protocols like Ethena are well-managed, many others are mixed.

In the highly competitive yield market, protocols seek higher returns by increasing leverage or deploying off-chain trading strategies (which may not be neutral). Meanwhile, decentralized lending protocols and Curators address some users’ concerns about unknown stablecoins — “I know you deposit in xxxUSD, but USDT or USDC are transparent, and your positions are visible on the dashboard. Why worry?”

This model has performed reasonably well over the past year, with no major collapses so far. The overall market trend has been upward, providing arbitrage opportunities, and most yield-bearing stablecoin protocols have maintained attractive returns. Many users have relaxed their vigilance, and double-digit yields on stablecoins and pools have become the new norm… but is this really sustainable?

Why do I strongly recommend a temporary withdrawal?

On October 11, the crypto market experienced an epic bloodbath, with hundreds of billions of dollars liquidated. Evgeny Gaevoy, founder and CEO of Wintermute, suspected that some hedge strategies suffered severe losses but was unsure who lost the most.

In retrospect, the failures of protocols like Stream Finance and others confirmed some of Gaevoy’s suspicions, but many hidden risks remain. Even those not directly liquidated on October 11 faced liquidity crunches afterward. The market’s risk aversion increased, and the arbitrage space shrank, putting pressure on yield-bearing stablecoins. Unexpected events often occur during such times, especially given the complex, opaque strategies underlying many liquidity pools, which can trigger systemic contagion.

Data from Stablewatch shows that, in the week of October 7, yield-bearing stablecoins experienced the largest outflow since the Luna UST collapse in 2022 — a total of 1 billion USD left the market, and the outflow continues. Additionally, Defillama reports that the total assets in pools managed by Curators have shrunk by nearly 30 billion USD since the beginning of the month. It’s clear that the market is reacting.

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DeFi is subject to the classic “impossible triangle” of investment markets — high yield, safety, and sustainability — which can never all be achieved simultaneously. Currently, “safety” is the most fragile factor.

You may be accustomed to depositing funds into stablecoins or yield strategies and have enjoyed relatively stable returns over time. But even products with consistent strategies are not risk-free. The current market environment is one of heightened risk and frequent unexpected incidents. Caution is advised — it’s wise to consider withdrawing at the right time, because when a low-probability event happens to you, it’s a certainty.