Living through low-risk DeFi: Retail investor survival strategies during a bear market

War. War Never Changes.

The direct triggers for the events on October 11 and November 3 were not yield-bearing stablecoins, but they dramatically struck USDe and xUSD in succession. By hardcoding USDe to peg to USDT, Aave prevented the on-chain crisis from spilling over into the Binance spot market, and Ethena’s mint/redeem mechanism remained unaffected.

However, this same hardcoding also prevented xUSD from crashing outright, leading to a prolonged garbage time. The issuer Stream’s bad debts couldn’t be cleared promptly, and related parties like Elixir and its yield-bearing stablecoin product deUSD faced scrutiny.

Additionally, multiple Curators on Euler and Morpho accepted xUSD assets, causing user funds in various vaults to randomly vaporize. Unlike the Fed’s emergency response role during SVB, these protocols lacked a safety net, raising the possibility of a liquidity crisis.

This single-point crisis escalated into industry-wide turbulence, as xUSD crossed from its sinking issuer into an eternal battle.

The Root of the Crisis? The Curator + Leverage?

The crisis wasn’t caused by leverage alone. It was due to protocol-to-protocol private dealings that led to opacity, lowering user risk awareness.

When the crisis erupted, two points formed the basis for responsibility attribution:

1. Stream and Elixir, through leveraged cycles, failed to issue sufficient xUSD, making their management teams the culprits.
2. Curated Markets on Euler/Morpho accepting “toxic assets” like xUSD meant platform and curator liabilities.

Let’s first examine the operation of YBS (Yield-Bearing Stablecoins). Compared to USDT/USDC, which are backed by dollar deposits in banks (including US Treasuries), and where Tether/Circle mint stablecoins against these deposits earning interest, the logic is straightforward: the stablecoin volume supports the profit margin of the issuers.

YBS operates differently. Theoretically, it uses an over-collateralization mechanism—issuing $1 stablecoin against collateral exceeding $1. Then, these assets are deployed into DeFi protocols to generate yield. After paying out profits to holders, the remaining is the issuer’s profit—its core revenue.

Image: YBS Minting, Yield, and Redemption Process

Source: @zuoyeweb3

In practice, under high-interest pressure, YBS projects have developed three “cheating” methods to boost profitability:

1. Converting over-collateralization into under-collateralized positions—though foolish and often ineffective—by mixing assets of varying safety:

   • “Safe” assets like USD cash (including US bonds), BTC, ETH are used, but assets like TRX backing USDD are discounted in value.

   • Combining on-chain and off-chain assets isn’t a bug but a form of temporal arbitrage—assets are audited at the right moment, and most YBS adopt this approach.

2. Amplifying leverage: Once issued, YBS tokens are funneled into DeFi protocols—mainly lending platforms—and often mixed with mainstream assets like USDC or ETH:

   • Pushing leverage to extremes—e.g., $1 collateral used as $100—can generate higher profits, such as Ethena combined with Aave/Pendle for a looped loan, achieving roughly 4.6x supply leverage and 3.6x borrow leverage after about five cycles.

   • Using fewer assets to leverage—like Curve’s Yield Basis, which once planned to directly issue crvUSD—reduces capital utilization.

xUSD employs a layered approach: leverage pre-positioned, with recursive issuance. As shown in the diagram, after minting, xUSD enters a yield “strategy,” essentially an increased leverage process. By coupling xUSD and deUSD, the issuance process is manipulated—users see both over-collateralization ratios and yield strategies, but this is just Stream’s smokescreen. Stream acts as both referee and participant, turning xUSD into under-collateralized YBS.

xUSD’s second-step leverage is used to further issue via deUSD, leveraging roughly 4x. Since 60% of issuance is controlled by Stream itself, profits are retained, and in a crisis, bad debts also stay with Stream. The critical problem: the absence of a proper liquidation mechanism socializes losses.

Why do Stream and Elixir do this?

Protocol-to-protocol dealings are no secret. Ethena’s integration with CEX capital grants some exemption rights during ADL (automatic de-leverage) liquidations. Regarding xUSD, Re7’s response is telling: “We recognized the risk, but at the strong request of users, we still listed it.”

Image: Re7’s Response

Source: @Re7Labs

While vault managers on Euler/Morpho could identify issues with YBS, under APY and profit motives, some still accept these assets—either actively or passively. Stream doesn’t need to persuade all managers; as long as some accept, the system persists.

These vault managers bear responsibility, but it’s a natural selection process. Aave didn’t become dominant overnight; it grew through crises. Would only relying on Aave make the market safer?

Not necessarily. If only one lending platform exists, it becomes the systemic risk source.

Euler/Morpho act as decentralized markets or “New Third Board,” offering more flexible configurations and lower entry barriers—crucial for DeFi’s expansion.

But opacity remains. Euler/Morpho’s Curators allow third-party sellers, unlike Aave/Fluid, which are fully self-operated. Interacting with Aave means trusting its security; with Euler, some vaults are managed by Curators, blurring responsibility.

In other words, Euler/Morpho lower user defenses and due diligence expectations. If they adopt Aave-like friendly forks or liquidity aggregation with clear front-end separation, criticism would diminish.

How Can Retail Investors Protect Themselves?

DeFi’s ultimate dream is to ring the bell for retail investors.

Vitalik, as the main advocate of Ethereum, isn’t particularly fond of DeFi. He’s long called for non-financial innovations on Ethereum, genuinely caring for retail. Since DeFi can’t be eliminated, he advocates for Low-Risk DeFi to empower the world’s poor.

Image: Vitalik’s View of DeFi vs. Reality

Source: @zuoyeweb3

Unfortunately, his idealized vision doesn’t match reality. People have long associated DeFi with high risk and high reward. During the 2020 DeFi Summer, yields often exceeded 100%. Now, even 10% returns are suspect as Ponzi-like.

The bad news: no high returns, but the good news: no high risks either.

Image: Ethereum Loss Rate

Source: @VitalikButerin

Data from Vitalik and other research shows DeFi’s safety is improving. Compared to Binance’s liquidation data and Bybit’s massive hacks, DeFi, especially YBS, has suffered minimal losses.

But here’s the caveat: This doesn’t mean we should blindly trust DeFi. While CEXs are becoming more transparent, DeFi’s opacity is increasing.

Regulatory arbitrage on CEXs is ending, but DeFi’s lax regulation era is returning—beneficial in some ways, but also leading to more centralized-like control within protocols and among Curators. Many terms are hidden behind Telegram commissions, and decisions by Curators can directly impact retail investors.

Regulation isn’t the main solution; instead, the focus should be on composability—using on-chain modules like over-collateralization, PSM, x*y=k, and Health Factor to support DeFi’s macro activity.

By 2025, the entire yield supported by YBS will mainly involve:

• YBS assets
• Leverage yield strategies
• Lending protocols

These are not countless; platforms like Aave, Morpho, Euler, Fluid, and Pendle cover about 80% of interactions.

Opacity in management leads to strategy failures. Curators haven’t demonstrated superior strategic design; failures occur after each crisis, prompting a necessary淘汰.

Beyond that, retail investors can attempt to see through everything—but it’s not easy. Both xUSD and deUSD are theoretically over-collateralized, but mixing them allows leverage to be front-loaded at issuance, making xUSD effectively under-collateralized.

When YBS is used to mint another YBS, the collateralization ratio becomes indistinguishable.

Until products capable of full transparency emerge, retail investors should rely on these beliefs:

1. Systemic crises aren’t socialized (they’re socialized risks). Participating in mainstream DeFi involves accepting inherent risks. Even Aave has had issues; DeFi can fail or restart.

2. Don’t rely on KOLs or media. Participation is subjective; information is just a reminder that “this product exists.” Whether KOLs warn or hype, or DYOR, ultimately, you must judge yourself. Professional traders often ignore news and rely solely on data.

3. High yields aren’t necessarily riskier than low yields. This counterintuitive view can be understood via Bayesian reasoning: high returns without failures imply low risk, and vice versa. But since we can’t quantify the odds precisely, these are independent events.

Use external data to adjust your beliefs, not to justify them.

Also, don’t overly worry about the market’s self-healing ability. Retail investors aren’t chasing volatility; capital seeks liquidity. When funds retreat to Bitcoin or USDT/USDC, the market naturally induces volatility—stability breeds new volatility, and crises of volatility lead to a pursuit of stability.

Looking at negative interest rate history, liquidity is the eternal hum of finance—volatility and stability are two sides of the same coin.

Conclusion

Retail investors should do two things in the upcoming YBS market:

1. Seek data—penetrate all layers of leverage and reserves. Transparent data doesn’t lie. Don’t rely solely on opinions to assess facts.

2. Embrace strategies—cycle through leverage and deleverage. Simply reducing leverage doesn’t ensure safety; always include exit costs in your strategy.

3. Control losses—while you can’t precisely control the loss ratio, you can set mental stop-loss levels based on points 1 and 2, and be responsible for your own cognition.