DeFi falls into the most dangerous prisoner's dilemma in history

Author: Gu Yu, ChainCatcher

More than 40 hours after the theft, the chain reaction triggered by Kelp DAO is still gaining momentum. It has not only pulled in more and more well-known projects such as Aave, LayerZero, and Arbitrum—it has even reached the point where certain popular narratives are being put on trial for death.

A well-known KOL, Feng Wuxiang, stated on the X platform that only ETH is safe now, and that ARB has also authorized the freezing and transfer of customers’ assets. None of the L2s is truly an L2 anymore. L2 rose with Arbitrum, and it also died with Arbitrum.

Another well-known KOL, Blue Fox, said that the biggest loss from this kelp incident was not Aave or Kelp, but LayerZero—yet it is too short-sighted to see what the entire event is really about. The essence of this event is not about discrediting L2 (fake L2 aside); it is about discrediting cross-chain bridges.

An increasing number of intense viewpoints are appearing in public discourse. The parties involved insist on their own narratives and argue back and forth, making the Kelp DAO theft incident a typical window into the clash between how to assign security responsibility and the conflict between pragmatism and technological fundamentalism.

I. Has L0 been disproved? Cross-chain bridges as the biggest loser

The key turning point of the incident is LayerZero’s detailed hacker attack report released yesterday. Early assessment suggests the attacker was the Lazarus Group with North Korean ties. The attack was carried out by poisoning the downstream RPC infrastructure on which its decentralized verification network (DVN) depends. The attacker controlled some RPC nodes and, together with DDoS attacks, induced the system to switch to malicious nodes—thereby forging cross-chain transactions.

“Using compromised nodes to poison the RPC infrastructure, and combining it with DDoS attacks on unaffected RPCs to force failover—this is very complex. At its core, this is an infrastructure war,” Samuel Tse, Head of Investments & Partnerships at Animoca Brands, commented.

At the end of the report, LayerZero stated that the protocol operated exactly as expected throughout the entire incident. No vulnerabilities were found in the protocol. The core feature of the LayerZero architecture is modular security. In this case, it perfectly achieved what it intended to do—isolating the entire attack within a single application, with zero contagion risk across the system. Other OFT or OApp were not affected either.

This complete removal of responsibility became the trigger for a massive public backlash, with many prominent industry figures expressing dissatisfaction with LayerZero’s performance in the incident.

“L0 washed itself clean, and in the whole article it dumped all the blame on KelpDAO configuration mistakes—insisting that it had no issues at all. Incredible. My question is: why is a 1/1 configuration allowed? Why can the attacker obtain the internal RPC list? Why does the failover logic trust the poisoned RPC directly after a DDoS, without stopping verification—or even doing something, anything?” industry researcher CM asked in return.

“This attitude of deliberate evasion really makes me uncomfortable. The statement clearly says ‘the protocol operated exactly as expected.’ The attack is described as RPC nodes being compromised and RPC poisoning taking place. But RPC poisoning isn’t that simple—your own infrastructure was invaded and damaged. Since the statement doesn’t explain how the intrusion happened, I won’t rush to re-enable the bridge,” the well-known DeFi developer banteg said.

Kelp DAO’s official response followed as well. It said that the single-validator (1/1) configuration that caused the attack was not a choice to ignore suggestions. Instead, it was the default setting in LayerZero’s official guidelines, and the validator network (DVN) that the attackers exploited was LayerZero’s own infrastructure.

According to Dune’s analysis, among the 2,665 LayerZero-based OApp contracts, 47% use a 1/1 DVN configuration—that is, a single-validator mechanism—which greatly and sharply expands industry risk.

More frightening than the problem itself is that the parties involved refuse to admit mistakes and instead evade responsibility. As the leading player in cross-chain communication and the Layer0 narrative, hundreds of crypto projects are using its cross-chain infrastructure to bridge tokens and assets across different chains. If it continues to maintain such an arrogant posture, it will inevitably further undermine the industry’s confidence in it.

Public opinion generally believes that even though LayerZero was not directly hacked, it suffered the greatest reputational damage. It must pay the price for “allowing weak configurations,” otherwise the cross-chain narrative will collapse.

In other words, LayerZero not only needs to propose clear technical improvement measures, but also needs to take more responsibility in asset compensation schemes.

II. Is Layer2 dead? Arbitrum’s extraordinary freeze

The discussion around Layer2 comes from Arbitrum’s freeze action. This afternoon, Arbitrum’s Security Council released a statement saying it has taken emergency action to rescue 30,766 ETH stored in the Arbitrum One address, currently worth 71 million US dollars.

Arbitrum also stated that after extensive technical investigation and deliberation, the Security Council determined and executed a technical plan to transfer the funds to a safe location without affecting any other chain states or any Arbitrum users. The original address holding the funds can no longer access them. Only the Arbitrum governing body can take further action to transfer these funds, and the action will be coordinated with the relevant parties.

Based on interpretations from industry participants, Arbitrum’s Security Council used a privileged state override transaction type (part of ArbOS, but basically never used), allowing the attacker’s private key to still sign transactions, while the ETH from that address is transferred by the chain itself.

This special transaction type fully bypasses the attacker’s private key. Only the chain itself (via the sequencer / the ArbOS upgrade path, controlled by the Arbitrum Security Council) can inject it.

It is reported that Arbitrum’s Security Council consists of 12 individuals. They are elected by Arbitrum DAO, and any decision requires approval from 9 out of 12 members.

A stone thrown into the pond stirred up a thousand ripples. Previously, many outside observers believed that Arbitrum, as a representative Layer2, lacked the capability and authority to handle users’ ETH assets—after all, this goes against the spirit of decentralization in blockchains.

In past hacks, stolen USDT and USDC were often able to be frozen immediately by Tether and Circle to reduce users’ losses. As a chain-native asset, ETH has never previously had any precedent of being frozen and transferred by the chain itself, and it has also gone beyond what most users expect.

Many viewpoints support Arbitrum’s approach—for example, “All companies, banks, and legitimate financial institutions will eventually adopt secondary architectures. Operating like a centralized entity at critical moments is not a flaw, but an advantage.” But for many technical geeks, this is not the case.

“Without a private key, without authorization, just transfer directly.” In many opinions, Arbitrum’s move effectively redefines the degree of decentralization in Layer2, which makes them lack a sense of security about Layer2.

Blue Fox was blunt: this incident directly touched the DeFi core ideological red line, “Not Your keys, not your coins.” Once again, the incident returns to the classic dilemma in crypto: pragmatic security versus fully decentralized security.

Conclusion

When LayerZero said “the protocol operated exactly as expected,” it preserved technical correctness, but it lost public opinion and trust. When Arbitrum used a privileged transaction to transfer 71 million US dollars worth of ETH, it saved users’ funds, but it seriously dealt a blow to Layer2’s decentralization narrative.

The Kelp theft uproar puts two of the hottest narratives on trial at the same time: Are cross-chain bridges truly infrastructure—or are they risk multipliers? Is Layer2 truly a reliable extension of Ethereum, or is it a secondary bank wearing a decentralized cloak?

Because of the breach of LayerZero’s single-validator-node mechanism, Arbitrum used a centralized special voting mechanism to recover losses for LayerZero and the Kelp DAO. This creates an extremely ironic closed loop: a supposedly decentralized protocol collapsed because of its “single point of weakness,” yet ultimately had to rely on another protocol’s “centralized privilege” to clean up the mess.

It forces the entire industry to face a question that has never been answered head-on: when the ideal of decentralization collides with real-world security costs, which side are we ultimately willing to sacrifice?

Discussions about grand narratives are one focus of public opinion, while users’ compensation plans are another focus of real-world public scrutiny. Even if Arbitrum recovers more than 70 million US dollars through technical means, Aave still has nearly 200 million US dollars of bad debt—so how should users’ interests be protected and upheld?

In the vast majority of hacking incidents, losses on the scale of tens of millions of dollars are essentially catastrophic for a protocol, and users’ claims for reimbursement often end without resolution. But this incident involves top projects such as Aave and Layerzero, so the handling of its bad debt has drawn intense attention.

Today, Aave proposed two possible solutions for its bad debt. The first is to socialize the loss among all rsETH holders (shared across the whole chain), with Kelp DAO applying a uniform value haircut of about 15% to all rsETH (mainnet + L2). The second is to let only rsETH holders on L2 bear all the losses, while mainnet rsETH keeps its original value.

However, to date, Kelp DAO and LayerZero have not discussed the role they play in the compensation plan. From LayerZero’s attempt to distance itself in the report, it is not hard to see that the project believes that without responsibility, there is no obligation to compensate.

Yet for a protocol with a valuation in the billions of dollars and treated as a foundational dependency by hundreds of projects, choosing “technical exemption” when facing huge losses caused by DVN default configuration is itself a massive irony of the very definition of “underlying infrastructure.”

This is a classic prisoner’s dilemma: in a crisis, all parties are trying to minimize their own losses through “slicing benefits,” rather than rebuilding industry trust by sharing responsibility.

Judging by the negative impact of this incident on industry parties, for DeFi this will be the most dangerous prisoner’s dilemma in history.