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The Evolving Threats Facing DeFi: Beyond Code Vulnerabilities

Decentralized Finance (DeFi) is under attack, but not in the way most developers are accustomed to defending against. While coding vulnerabilities have traditionally been the primary focus, a new wave of exploits now targets economic and incentive design flaws that go unnoticed beneath flawless programming.

Economic Exploits: The New Frontier of DeFi Attacks

Recent events highlight the growing sophistication of these economic exploits. One notable example is the JELLY token incident on Hyperliquid, where attackers siphoned over $6 million by manipulating economic mechanisms rather than exploiting coding errors. The attack leveraged a short squeeze, abusing the platform’s liquidation logic and risk parameters to devastating effect.

Similarly, Polter Finance, a lending protocol on Fantom, faced a $12 million flash loan attack. This exploit manipulated the platform’s price oracle, tricking the system into accepting worthless collateral as valuable assets. While the code functioned as intended, the flawed economic design exposed the platform to catastrophic losses, forcing Polter Finance to shut down entirely.

These incidents underscore a critical point: impeccable code alone cannot protect projects built on unstable economic foundations. Clever adversaries are increasingly targeting protocols by exploiting market inputs, governance mechanisms, and incentive structures, leaving projects vulnerable to unforeseen risks.

Why Traditional Audits Fall Short

Most DeFi audits focus on ensuring that β€œthe code does what it’s supposed to do.” However, this approach overlooks a crucial question: does the system’s design hold up under adversarial conditions? Unlike traditional software, DeFi protocols operate in dynamic and adversarial environments where prices fluctuate, user strategies evolve, and interconnected systems amplify risks.

While many teams employ skilled engineers to identify software bugs, few have the economic expertise to analyze vulnerabilities in incentive structures and market logic. This gap leaves projects exposed to economic exploits that traditional audits fail to catch.

Integrating Economic and Game-Theoretic Analysis

To address these blind spots, audits must go beyond code reviews to include rigorous economic and game-theoretic analysis. This involves scrutinizing key elements such as:

  • Fee mechanics
  • Liquidation formulas
  • Collateral parameters
  • Governance processes

Auditors need to ask critical questions like, β€œHow could someone profit by bending these rules?” For instance, Oak Security recently flagged a vulnerability in a perpetual swaps platform’s insurance fund. The platform’s pricing model failed to account for β€œvega risk,” or sensitivity to market volatility, which could have led to a collapse during turbulent market conditions. This issue was a design flawβ€”not a coding bugβ€”and was only identified through economic analysis before the platform’s launch.

Steps Founders and Investors Should Take

For founders and investors, it’s imperative to demand more comprehensive audits that examine all aspects of a protocol, including off-chain components and economic assumptions. Key questions to ask auditors include:

  • Have you accounted for oracle manipulation?
  • What happens during liquidity crunch scenarios?
  • Did you analyze the tokenomics for potential attack vectors?

If these questions are met with silence or vague answers, it’s a red flag. Incorporating economic and game-theoretic analysis into the audit process is no longer optionalβ€”it’s a necessity for the survival of any DeFi project.

The Path Forward: Raising the Bar for DeFi Security

The DeFi industry must evolve its approach to security by integrating economic reviews alongside code audits. By fostering a culture where both dimensions are scrutinized, projects can better protect themselves against increasingly sophisticated threats. The cost of ignoring these blind spots is too high, as the repeated losses from economic exploits have shown.

β€œLet’s raise the bar nowβ€”before another multimillion-dollar lesson forces our hand.”

About the Author: Jan Philipp Fritsche is the managing director of Oak Security, a cybersecurity firm specializing in web3 audits. With extensive experience in econometric and risk modeling, he has held positions at institutions such as the European Central Bank and DIW Berlin. He earned his Ph.D. in Economics from Humboldt University of Berlin.

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