Original Title: What Should DeFi Rates Really Be?

Original Author: Tom Dunleavy, Head of Varys Capital

Original Compilation: Chopper, Foresight News

KelpDAO experienced a $292 million cross-chain bridge attack, with the risk spreading to Aave, causing the total value of locked assets in DeFi to evaporate by $13 billion within 48 hours.

If you deposit USDC in the money market earning only 5% returns, the real key issue is not whether DeFi has risks, but whether: your returns match the risks you are taking.

This article will analyze this question using bond pricing logic.

Two weeks ago, attackers stole $292 million from KelpDAO, and the stolen rsETH was subsequently re-deposited into Aave V3 as collateral, directly causing Aave to incur about $196 million in bad debt. In just three days, the total value of assets locked in Aave plummeted from $26.4 billion to $17.9 billion.

Prior to that, two weeks earlier, the Drift Protocol in the Solana ecosystem was compromised through a social engineering attack on the admin’s private key by North Korean hackers, losing $285 million. The planning for this attack can be traced back to fall 2025.

Just three weeks between these two major security incidents, totaling a loss of $577 million. Due to risk depegging, Aave’s USDC lending market utilization rate stayed at 99.87% for four consecutive days, with deposit rates soaring to 12.4%. Circle’s chief economist Gordon Liao even proposed a governance measure to quadruple the lending cap to ease withdrawal pressures.

A month ago, many users deposited stablecoins into DeFi money markets, earning only 4%–6% annualized returns.

Now everyone must confront a core question: Is this kind of yield rate pricing itself reasonable? As early as a few weeks before the KelpDAO incident, Santiago R Santos questioned on the Blockworks podcast: In DeFi, we bear high risks long-term but have never received adequate risk compensation. In the future, the fair risk premium for various assets should be redefined.

How Traditional Finance Prices Credit Risk

The yields on all corporate bonds are composed of multiple layers of risk premiums. The core pricing formula is as follows:

· Yield = Rf + [PD x LGD] + Risk Premium + Liquidity Premium

· Rf is the risk-free rate, benchmarked against the US Treasury yield matching the bond’s duration.

PD × LGD is expected loss = probability of default × loss given default, where loss given default = 1 - asset recovery rate. The risk premium compensates for uncertainties beyond expected loss; even if two assets have identical PD and LGD, differences in the volatility of risk outcomes can lead to different prices. The liquidity premium accounts for additional costs of asset discounting and exit.

Based on Moody’s long-term historical data since 1920, the reference benchmarks are as follows:

· Long-term average default rate for US speculative-grade bonds: 4.5%, recent 12 months at 3.2%, expected to rise to 4.1% in Q1 2026;

· Historical average recovery rate for senior unsecured high-yield bonds: about 40%, corresponding to a default loss rate of approximately 60%;

· Long-term annual expected loss for high-yield bonds: 4.5% × 60% = 2.7%;

· In private credit, KBRA forecasts a direct lending default rate of 3.0% in 2026, with an average recovery rate of about 48% in 2023–2024;

· Historical recovery rate range for senior secured leveraged loans: 65%–75%.

Traditional Financial Yield Tiers in April 2026

Let’s look at current actual data. The 10-year US Treasury yield closed last Wednesday at 4.29%. At the same time, we examine the ICE BofA US Investment Grade Option-Adjusted Spread for April 2026.

Clear and common-sense pricing logic: Moving down the capital hierarchy from Treasuries, investment-grade bonds, speculative-grade bonds, to subordinate commercial real estate assets, yields increase in tandem to compensate for rising default probabilities and loss severity.

Private direct lending yields remain around 9%, not because borrowers have higher default rates, but mainly due to the extremely poor liquidity of non-standard private assets, which significantly inflates the liquidity premium.

In contrast, in the DeFi market: Before the KelpDAO incident, Aave’s USDC deposit rate was about 5.5%, positioned between investment-grade bonds and single B high-yield bonds. Meanwhile, the yield on Morpho, which relies on curated vaults and active management, is about 10.4%. These two figures cannot both accurately reflect the same underlying risk.

DeFi’s Three Unique Default Modes, Non-Existent in Traditional Finance

Traditional credit default processes are tedious. Borrowers cannot pay interest, bondholders trigger acceleration clauses, companies undergo restructuring, assets are liquidated, and negotiations for asset recovery are lengthy and negotiable.

But DeFi lacks a debt restructuring mechanism. The main threats come from protocol attacks, which fall into three completely different failure modes, each with its own loss characteristics.

Mode One: Smart Contract Vulnerability Attacks

Code vulnerabilities cause theft, such as reentrancy attacks, parameter validation failures, lack of permission controls, etc. Attackers directly drain the liquidity pool. Historical data shows: protocols hacked by white-hat hackers recover only 5%–15% of funds on average; if involving North Korean state-level hackers, recovery is nearly zero.

In 2021, Poly Network’s $611 million theft was fully reimbursed, an extreme case; Ronin’s $625 million and Wormhole’s $325 million hacks were ultimately recovered, relying on project teams and market makers to cover losses, not market-based asset recovery—essentially shareholder compensation.

Mode Two: Oracle Manipulation and Governance Attacks

Maliciously manipulating price feeds in low-liquidity decentralized pools to create bad debt; or attackers hoarding governance tokens and passing malicious proposals to drain treasury funds. The 2022 Beanstalk attack, which resulted in a loss of $182 million, is a typical example. While some losses can be mitigated through protocol intervention, the assets held by lenders often become worthless token holdings.

Mode Three: Composability Chain Reactions

The KelpDAO incident belongs to this category, and it’s the most dangerous and hardest to audit or predict. Protocol A issues liquidity staking/re-staking derivatives, Protocol B accepts these assets as collateral, and Protocol C handles cross-chain asset bridging.

If any link in this chain is attacked, it can trigger a cascade of failures downstream. Attackers don’t need to breach Aave itself—just break through the upstream rsETH protocol, and Aave lenders will face massive bad debt.

These three risk types share a common feature: risk explosion occurs within minutes, not quarters. No contractual negotiations, no bankruptcy bailouts—smart contracts execute automatically, code is law. Once a vulnerability exists, losses can be nearly total and irrecoverable. The bad debt of rsETH in Aave V3 soared from zero to $196 million in about four hours. In contrast, traditional BB-rated high-yield bonds take a median of 14 months from risk warning to debt restructuring.

Real Loss Data Reveals the Truth

Chainalysis’s mid-2025 report reveals a contradictory set of data: from early 2024 to October 2025, the total value of DeFi locked assets rebounded from $40 billion to $1.75 trillion, but losses from DeFi-specific hacks remained at the low levels seen in 2023.

In 2025, total crypto asset thefts amounted to $3.4 billion, with high concentration in hacks on centralized exchanges and personal wallets.

Looking at this data alone, it’s easy to misjudge that DeFi’s security is continuously improving. The objective facts do exist: mature contract auditing industry, platforms like Immunefi offering bug bounty protections for over a trillion dollars in user assets, cross-chain bridges gradually adopting time locks and multi-party verification.

But the reality in 2026 is quite the opposite: on April 1, Drift lost $285 million; on April 18, KelpDAO lost $292 million. Two incidents within 18 days, both targeting composability architecture vulnerabilities rather than the lending protocols themselves.

Based on the average locked asset scale, estimated annualized DeFi loss rates in recent years:

· 2024: DeFi-specific losses about $500 million, with an average locked value of $75 billion → annualized loss rate 0.67%

· 2025: Losses about $600 million, with an average locked value of $120 billion → annualized loss rate 0.50%

· 2026 (year-to-date, annualized): just in Q2, two incidents caused losses of $577 million, with an average locked value of $95 billion → if risk trends continue, annualized loss rate could reach 2.0%–2.5%

Based on this, the forward-looking annualized default probability for top DeFi lending platforms is approximately 1.5%–2.0%. Considering an extreme scenario with 90% loss given default (when no external backstop exists, typical theft recovery rates are only 5%–15%), the expected annual loss is 1.35%–1.80%. This figure already exceeds traditional high-yield debt, not counting uncertainty premiums, liquidity discounts, regulatory risks, or cross-chain contagion risks.

Reasonable Risk Premium Model for DeFi

Based on bond pricing logic, we estimate the fair yield for top DeFi stablecoin deposits: benchmarked against leading protocols on Ethereum mainnet (Aave, Compound), fully collateralized, targeting retail and quantitative borrowers of USDC loans.

Building a fair value yield from the 10-year Treasury yield benchmark

Using the 10-year US Treasury as the base, adding premiums layer by layer:

· Risk-free benchmark (10-year US Treasury): +4.30%

· Expected fixed loss: +1.50%

· Oracle manipulation risk premium: +0.75%

· Governance / private key risk premium: +1.00%

· Cross-protocol composability chain risk (similar to Kelp): +1.25%

· Regulatory asymmetry risk premium: +1.25%

· Stablecoin de-peg tail risk: +0.50%

· Asset liquidity premium: +0.50%

· Risk premium: +1.50%

Final fair annualized yield: 12.55%.

Therefore, ideally, the fair interest rate for leading compliant DeFi stablecoin deposits should not be below 13%. Assets with insurance coverage and protocol reserves can have moderately lower rates; newer protocols, markets, or those involving re-staking and cross-chain assets require higher risk premiums.

Conclusion

First, seek fair compensation. If you offer USDC to DeFi at a 5% yield, you are effectively pricing BB-grade credit risk, which has higher technical and composability risks than CCC-grade. Curated vault markets like Morpho, with yields between 9% and 12%, are closer to fair returns, but they also introduce management and transparency issues.

Second, improve capital structure. Overcollateralized loans backed by quality collateral (ETH, wBTC, proven LSTs), supplemented with oracle redundancy and protocol-level insurance, and avoiding cross-chain risks, have risk premiums far below the above framework. These are the “investment-grade assets” in DeFi.

Third, properly assess tail risks. The KelpDAO vulnerability is not a black swan but a foreseeable failure mode of re-staking primitives connected to increasingly fragile multi-chain architectures. Drift’s case is similar, just with different participants.

In Q2 2026, a total of $577 million in permanent losses have been recorded. A DeFi portfolio earning 5.5% cannot fully cover the risks of extreme crashes and chain reactions.

DeFi is not uninvestable; it is just currently mispriced. Institutional-grade allocation opportunities do exist, but only if capital providers demand risk-matched premiums or conduct deep due diligence on individual protocols with rigorous standards.

Blindly depositing into top-tier money markets and passively accepting low yields is just a high-risk spread trade disguised as risk-free investing.

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