Kelp DAO’s bad debt is resolved, and Aave absorbs a hundred-billion-dollar loss

Author: Sanqing, Foresight News

On May 26, Kelp DAO transferred the final batch of 20,373.72 rsETH into the LayerZero OFT Adapter, and Aave simultaneously announced that rsETH and all affected markets have returned to normal. In 37 days, a total of 116.5k rsETH have been fully replenished.

But this is only a re-pegging of rsETH to 1:1 backing, not a complete zeroing out of Aave’s on-chain balances. The 30,766 ETH frozen by the Arbitrum Security Council are still stuck in the Southern District of New York Federal Court, with ownership undecided. The lost TVL of Aave also cannot come back along with rsETH.

The bills are not just on the TVL line

According to DefiLlama data, on April 18, the day the incident occurred, Aave’s TVL was $116.5k; by May 25, it was $26.4B. The money that hasn't come back after a month exceeds $12 billion.

The more difficult issues lie ahead. The Southern District of New York Federal Court will hold a hearing on June 5 regarding the ownership of the 30,766 ETH frozen by the Arbitrum Security Council. Aave LLC and Gerstein Harrow have submitted supplemental briefs before May 22. The judge had previously modified the restraining notice on May 8 to allow fund transfers, but a substantive ruling is still pending and will be decided on June 5.

Gerstein Harrow represents the families of North Korean terrorism victims and holds an unexecuted judgment of $877 million. Regardless of the outcome, this lawsuit is a drain on Aave’s brand.

The reason DeFi United was able to rally this time is because multiple parties were willing to backstop: Stani Kulechov personally contributed 5,000 ETH, Consensys and Joseph Lubin pledged up to 30,000 ETH, the Aave treasury allocated up to 25,000 ETH, plus Mantle provided a credit line of up to 30,000 ETH, supported by Lido, Ether.fi, and others.

The community mobilization was unprecedented, but Aave has overdrawn on this one-time card. If another upstream contamination event occurs, it may not be possible to assemble the same list of supporters again.

For example, after the incident, Sun Yuchen moved about $174 million (including 65,854 ETH and several stablecoins) from Aave to Spark, with total deposits in Spark exceeding $1.3 billion. Whales are voting with their feet; the funds have already migrated.

V4’s openness is being slowed down by governance

Aave’s countermeasures are not limited to V4, but V4 is the most central one.

V4 was launched on the Ethereum mainnet on March 30, adopting a Hub-and-Spoke architecture with three initial Liquidity Hubs. Aave Labs promised “security-first growth,” gradually increasing deposit caps. On April 8, deposits surpassed $10 million; by May 9, it crossed $50 million; on May 26, total deposits reached $86.13 million, with active lending positions at $27.77 million.

This pace was a responsible design choice before rsETH, but after rsETH, it became a stress test. Aave is bearing $200 million in bad debt on V3 while slowly expanding the limits on V4.

More complicated is that V4 also faces internal conflicts within its governance. In February 2026, Aave Labs submitted a strategic proposal that bundled product revenue, service provider incentives, V4 growth engine, and brand legal custody into a single vote, requiring approval across four different risk dimensions.

Marc Zeller, founder of the Aave Chan Initiative, publicly questioned whether it was appropriate to bundle large fund requests and strategic approvals into one. This governance dispute has been fermenting before and after V4’s launch, and each delay allows competitors to eat away a bit more market share.

The advantage of V4 is the openness of its Spoke design, allowing anyone to build a Spoke; if qualified, they can connect to the Liquidity Hub as a credit line. That’s why Babylon Labs chose to integrate Trustless Bitcoin Vaults into V4 rather than another platform. But the speed of realizing this openness depends on whether governance can keep pace.

Not just V4, Aave is fighting three battles

Aave V3 remains a cash cow. Annual revenue exceeds $100 million, with TVL of 14.1 billion mainly on V3. The “Aave will win” proposal positions V3 as a “stability maintenance” phase, with Stani publicly promising no forced migration and no deadline.

V4 and V3 will run in parallel for at least 24 to 36 months, serving as an additive layer to cover scenarios V3 cannot handle. Horizon is an independent, permissioned fork of V3, specifically serving institutional RWA.

Each layer targets different incremental growth. V4 addresses new scenarios that V3’s risk architecture cannot accommodate; rsETH added a new task—to give funds migrated to Morpho and Spark a reason to return to Aave. Horizon targets traditional financial RWA flows, completely separate from V3 and V4.

Horizon Market officially launched in August 2025, as a permissioned V3 instance deployed by Aave, allowing institutions to use tokenized government bonds, corporate bonds, and money market funds as collateral to lend USDC, GHO, RLUSD, and other stablecoins.

As of May 26, it has accumulated over $500 million in net deposits, aiming to reach $1 billion by the end of 2026, with partners including BlackRock, Franklin Templeton, Circle, Ripple, and VanEck.

This route is different from Morpho’s vault management model. Morpho curates vaults through third-party institutions like Steakhouse and Gauntlet to capture retail lending flows from Coinbase, while Aave’s Horizon directly interfaces with traditional asset managers for RWA.

The two paths are separate in terms of institutional client profiles. Morpho serves fintech companies that treat on-chain lending as a tool, while Aave serves asset managers that use on-chain as an issuance platform.

The fund migration after the rsETH incident mainly affects the first type of client. The second type faces higher migration costs and slower reactions. The compliance framework, KYC processes, and asset onboarding audits accumulated on Horizon are not easily replicable by Morpho in the short term.

This is the only incremental line of growth for Aave that was not directly impacted by the rsETH event, but its growth depends on the pace of traditional finance’s integration into DeFi.

No second DeFi United

Aave remains the largest lending protocol, with $14.1 billion TVL still nearly double that of Morpho, with years of deployment depth that no one can catch up to in the short term.

But the bills left by rsETH are not on the balance sheet; they are in the institutional sector’s default preference for lending protocols. Spark’s TVL increased from $14.18B to $5.3 billion in one month; Morpho slowly recovered from its April 21 bottom to pre-incident levels. These figures will not automatically flow back just because Aave’s market recovers.

The speed of realization of V4’s heterogenous scenario capabilities, plus Horizon’s progress in institutional RWA, will determine whether Aave can regain lost market share. But the former is hindered by governance internal conflicts, and the latter by the pace of traditional finance’s own onboarding. Both issues are waiting on Aave.

DeFi United is not a permanent institution; it was a one-time gathering.