Chaos Labs Risk Report: Insights from Recent Market Events - 02/02/26

[ChaosLabs]

Overview

Over the last 7 days, broad crypto prices experienced significant volatility, with major assets dropping by 10-20%, triggering substantial liquidation volume across Aave deployments. During the event, the Aave DAO profited $980K from liquidation fees and 804 ETH ($1.85M) from SVR recapture, with a minimal deficit accrued of $30K stemming from a BAL collateralized position. Aave liquidation engine performed admirably during the liquidation cascade, ensuring timely execution and a net profitable outcome.

Liquidation Volume

Liquidations were concentrated in the Ethereum Core market, with the largest daily notional occurring on 31/01 and additional elevated activity on 02/02. Across the full 7-day window, total collateral seized reached $202.47M against $193.12M of repaid debt, with $9.34M paid out in liquidation bonuses. The primary assets affected by the liquidations were WETH, WBTC, and cbBTC across all Aave instances, with some additional liquidation volume driven by LINK and AAVE collateral.

Bad Debt and Deficit Realization

Protocol losses were minimal relative to the size of the liquidation volume. The only material deficit cited for the event was a ~$30k realized shortfall from a BAL-related position, tied to the provided transaction hash.

This deficit was caused by a drastic drop in the BAL price, which suffered a 60% drop over a span of 2 hours. The drop was caused by the liquidation of the BAL holder humpy.eth, which represented the majority of the BAL collateralized position across lending markets.
Following this liquidation, the size of the BAL market has shrunk by over 95%, leaving minimal existing BAL collateralized debt exposure.

This deficit realized against BAL collateral is consistent with the deprecation efforts pushed forward in the last 2 months. As liquidity and demand for the asset decline, liquidation execution quality can deteriorate during volatile markets, increasing the likelihood of residual deficits even when the broader system clears efficiently.

As such, Chaos Labs recommends a further deprecation step following the event and will recommend a reduction of the BAL supply cap to 1 in a following Risk Steward update.

SVR Performance and Revenue Attribution

SVR liquidations contributed meaningful value capture during the last 7-day period.
With liquidation volume executed through SVR accounting for 118.37M collateral seized, along with generating $2.8M of value recaptured over the duration of the event, of which 65% ($1.85M) represents Aave’s profit split.

Conclusion

This drawdown produced large liquidation volumes without any significant liquidation issues. The only event’s realized deficit was limited to ~$30k, concentrated in BAL. In contrast, liquidation revenues totaled to $2.83M accounting for Liquidation Fee and SVR Recapture. On a net basis, SVR revenue alone dominated deficit realization, making the event economically net positive for Aave.

Disclosure

Chaos Labs has not been compensated by any third party for publishing this analysis.

Copyright

Copyright and related rights waived via CC0.

[abdulwahed]

Subject: Architectural Implications of the BAL Liquidation Event on V4 Design

The recent BAL liquidation event provides critical empirical evidence: 60% collateral drawdowns within a 2-hour window are not theoretical edge cases—they are observable market realities.

The V3 Success Factor: Aave V3 achieved a net-positive outcome because of its Monolithic Settlement Model. Revenue (liquidation fees) and Deficit (bad debt) were realized within the same accounting domain and netted instantly.

The V4 (Model D) Risk: This highlights a pivotal architectural question for the proposed Hub-and-Spoke design:

Is there a protocol-level invariant in V4 that guarantees this same temporal coupling between deficit realization and revenue recognition?

Without a strict Ex-Ante Solvency Gate, a similar BAL-like event inside a Spoke creates a dangerous decoupling:

1. The Hub recognizes and potentially distributes revenue immediately.
2. The Spoke holds the unresolved deficit ($30k in this case, or much more at scale).

This creates “Phantom Solvency”—profit recognition preceding loss absorption. While V3 is immune to this due to its unified state, segmented architectures are structurally vulnerable to it.

This distinction is vital. We cannot rely on V3’s “ex-post” efficiency to validate V4’s “ex-ante” safety. This requires an explicit invariant at the Hub level.