Balancer vulnerability butterfly effect! XUSD de-pegging exposes DeFi leverage crisis

After the multi-chain DeFi platform Balancer v2 was subjected to a vulnerability attack, Berachain urgently executed a hard fork, and SonicLabs froze the attacker’s wallet. Subsequently, the price of Stream Finance’s XUSD stablecoin plummeted to $1.15, a fall of 8.7%, and withdrawals were paused. This chain reaction exposed long-standing transparency issues in DeFi, as well as risks related to leverage and oracles.

Balancer Vulnerability Attack Sparks Information Vacuum Panic

(Source: Chaos Labs)

Balancer v2 vulnerabilities erupted across multiple chains, and for a considerable period, it was unclear which liquidity pools were affected, or which networks or integrated protocols were directly exposed to risk. This information vacuum created ideal conditions for market panic. In the DeFi space, when an attack occurs but the scope of impact is unknown, investor reactions are highly predictable: better to mistakenly punish many than to overlook one.

As a multi-chain liquidity protocol, the scope of Balancer’s vulnerability impact is extremely difficult to assess immediately. Attackers may have exploited reentrancy vulnerabilities in smart contracts or manipulated price oracles, but at the early stage of the event, even the protocol teams could not immediately identify all affected pools and chains. This uncertainty made any protocol integrated with Balancer a potential risk.

In this information vacuum, capital reactions are consistent: depositors rush to withdraw liquidity from any place they believe might be directly or indirectly affected, including Stream Finance. This panic withdrawal is not based on evidence of a technical flaw in Stream Finance itself but on concerns about potential indirect risks. However, this seemingly irrational panic has revealed deeper structural issues.

Berachain’s emergency hard fork and SonicLabs’ freezing of the attacker’s wallet demonstrate the flexibility of blockchain ecosystems in crisis response but also highlight a paradox: decentralized systems often require centralized decision-making to stop losses during crises. This contradiction exacerbates market uncertainty, leading investors to question whether they are participating in a truly decentralized system or merely a centralized finance operating under a decentralized guise.

XUSD Depegging Reveals Critical Transparency Deficiencies

(Source: CoinGecko)

Stream Finance’s XUSD stablecoin significantly deviated from its target range, falling from $1.26 to $1.15, then rebounding to $1.20, while withdrawals were paused. This price movement itself exposes a problem: why is XUSD’s target price $1.26 instead of $1? The answer lies in its design as an “accumulating yield dollar product,” which theoretically should continuously generate returns and be reflected in its price.

Currently, Stream Finance does not maintain a comprehensive transparency dashboard or proof of reserve; it only provides a link to the Debank Bundle showing its on-chain positions. In normal times, this minimal disclosure might suffice; but during a crisis, it fails to answer the most critical questions for investors: Is my funds safe? Is the protocol directly or indirectly exposed to the Balancer vulnerability?

When XUSD’s price started to fall, the market quickly shifted from “probably fine” to “redeem immediately.” The speed of this shift highlights the market’s high sensitivity. In the absence of transparency, any negative news can trigger a trust crisis, which in DeFi often rapidly turns into a liquidity crisis. The suspension of withdrawals further fuels fears, confirming investors’ worst-case scenario: the protocol may indeed be facing liquidity issues.

Stream Finance is an on-chain capital allocation platform that uses user funds to operate high-return, high-risk investment strategies. Its portfolio construction involves significant leverage, making the system more vulnerable under stress. Recently, the protocol has become a focus of public attention due to controversy over recursive cycles/minting mechanisms. While the current situation does not directly indicate a liquidity crisis, it reveals how quickly a system can shift from stability to collapse when negative news emerges and confidence is questioned.

$84 Million Collateral Risk and Oracle Traps

(Source: Euler)

XUSD is used as collateral across multiple chains’ Curated Markets, including Euler, Morpho, and Silo, covering ecosystems like Plasma, Arbitrum, and Plume. The protocol itself has significant risk exposure in these markets, with the largest being $84 million USDT borrowed against XUSD on Plasma. The significance of this figure is that if XUSD is liquidated on a large scale, it could trigger a chain reaction across the entire DeFi ecosystem.

When XUSD’s market price falls below its on-paper value, related positions are not immediately liquidated. This is because many markets do not peg collateral value to spot AMM prices but rely on hardcoded or “base value” feeds, which track reported asset support rather than current secondary market prices. This design can mitigate unfair liquidations caused by short-term volatility during calm periods, which is one reason DeFi protocols performed better than centralized platforms during the October 10 liquidation wave.

However, this design can also turn price discovery into trust discovery. Choosing a base (or hardcoded) oracle requires thorough due diligence, including verifying asset backing, stability, and risk characteristics. In short, such mechanisms are only suitable when comprehensive proof of reserves exists and redemption can be completed within a reasonable timeframe. Otherwise, lenders or depositors risk ultimately bearing bad debt.

The Double-Edged Sword of Base Oracles

Advantages: Prevents chain reactions of liquidation caused by short-term market volatility, protecting borrowers from unfair liquidations

Risks: When a genuine liquidity crisis occurs, delayed price discovery may cause lenders to suffer greater losses

Key Condition: Must be paired with comprehensive proof of reserves and verifiable redemption mechanisms

For example, on Arbitrum, the current market price of MEV Capital Curated XUSD Morpho Market is below LLTV (Lowest Loan-to-Value). If the peg price of XUSD cannot recover, and utilization reaches 100% with borrowing interest rates soaring to 88%, the situation could worsen further. Such an extreme interest rate environment would drive out all rational borrowers, leaving only bad debts that cannot or will not be repaid.

DeFi Black Box Problems and Curated Markets’ Responsibility

This crisis exemplifies the typical “reflexive pressure event” outlined in last week’s article “DeFi Black Box / Vaults.” Reflexivity refers to market participants’ expectations influencing fundamentals, which in turn reinforce those expectations, creating a self-reinforcing cycle. In the XUSD case, the Balancer vulnerability triggered redemption fears, leading to a price fall, which intensified panic, prompting more redemptions, and forming a vicious cycle.

Long-term debates over leverage, oracle construction, and proof of reserve transparency are once again in focus. These are not new issues, but each crisis re-raises them under the spotlight. The core question remains: as DeFi protocols pursue high yields, do they sacrifice fundamental risk management and transparency standards?

Curated Markets can serve as responsible growth engines, but they must not become arenas where the pursuit of high returns sacrifices safety and rationality. If built as a “domino-like” complex structure, it should not be surprising if it collapses when the first breeze blows. As the industry becomes more professionalized and some yield products become more structured (but potentially more opaque to end users), risk-related parties must raise their standards.

This incident should serve as a wake-up call for the entire DeFi industry: transparency is not a luxury but a necessity. When protocols manage hundreds of millions of dollars in user funds, simple Debank links are far from enough. The industry needs to establish standardized proof of reserve frameworks, real-time risk dashboards, and verifiable redemption mechanisms.