Jeter

The fallout from the Kelp rsETH exploit is going to be messy and could potentially be quite a bit more severe than some people are making out right now. It seems rsETH on mainnet is technically still backed, but, there's no liquidity to sell rsETH, and with rsETH contracts paused, there’s currently no usable redemption path either. In the unlikely case they socialised the loss across all rsETH holders, it would be worth something like 81.25% (1 - $300m/$1.6b) of its original value. I don't think they will do that though. It would likely push a number of large positions on Aave towards undercollateralisation and risk creating bad debt. That alone would be enough to trigger a long and painful lawsuit. So realistically rsETH holders on L2s are likely going to swallow the loss. Who are they? Why did they have rsETH on L2s in the first place? Could be other DAOs or funds etc who've taken a huge hit. That alone could have consequences we won't know about for some time. Impacted individuals on L2s will likely consider their own legal action to force socialisation, potentially prolonging the delay before redemptions are opened. Either way, once redemptions are eventually opened, it's unlikely any lending protocols would re-allow collateralisation, so there will be need to be a massive unwind of huge volume of rsETH/ETH looping trades. All those looping trades are currently massively negative ROE. Aave ETH utilisation is currently at 100% with ETH borrow rate at 8.71%. Since staked ETH yield is around 2.5%, the ROE for any LST or LRT borrow or looped borrow is anywhere between -6.21% and around -90%, depending how degen people are. So we could see an unwind of lots of LST loops aside from just rsETH/ETH ones. The normal path to unwind a loop is to swap collateral and repay, but this is unlikely to be possible for such a large amount of unwinds at once, and certainly won't be feasible for rsETH unless someone puts up significant liquidity for it. When the swap and repay path fails, you normally have to withdraw as much collateral as you can, manually redeem, repay some debt, withdraw more collateral, and so on. Here's the kicker. If rsETH is no longer collateral and no longer has borrowing power, this makes it much more difficult for people to manually unwind as well. If people get stuck for longer periods paying huge negative ROE for too long, and there’s no liquidity to liquidate them, their equity gets eroded. Once debt exceeds recoverable collateral value, bad debt appears, and can keep worsening as interest accrues and the position remains unresolved.

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