Circle Chief Economist Gordon Liao has called for a sharp increase in USDC borrowing rates on Aave V3’s Ethereum Core market, arguing that the protocol needs a much steeper rate curve after the KelpDAO exploit left liquidity effectively trapped for days.
The proposal was submitted on April 22, 2026, as an Aave Request for Comment. It came in the aftermath of the April 18 exploit involving KelpDAO’s rsETH bridge, an incident that did not directly compromise Aave’s smart contracts but nevertheless triggered severe stress across Aave’s lending markets. In particular, it pushed key pools toward full utilization and made withdrawals increasingly difficult for depositors trying to exit.
A two-step plan to reprice USDC liquidity
Liao’s proposal centers on changing the parameters that determine how borrowing costs rise once utilization moves beyond the protocol’s optimal level. In the first phase, Aave’s Risk Steward would immediately raise Slope 2 from 10% to 40% and lower optimal utilization from 92% to 87%. In the second phase, which would require a full governance vote, Slope 2 would be increased further to 50% and optimal utilization reduced again to 85%.
Under that target configuration, USDC borrowers on the Ethereum Core market could face a maximum borrowing rate of roughly 53.5% at 100% utilization, a dramatic shift from the current ceiling of about 14%. Other parameters would remain unchanged, including Slope 1 at 3.5%, the base rate at 0%, and the reserve factor at 10%.
The logic behind the proposal is straightforward: if borrowing costs remain too low when a pool is nearly exhausted, users who are insensitive to rates have little incentive to repay or unwind positions. In that environment, capital remains stuck, depositors cannot withdraw, and the market fails to clear. Liao argues that Aave needs a much steeper post-kink rate curve to force proper price discovery during stress events.
How the KelpDAO exploit spilled into Aave
According to the report, attackers exploited a vulnerability in KelpDAO’s cross-chain bridge infrastructure to siphon unbacked rsETH. That asset was then deposited as collateral on Aave V3, allowing the attackers to borrow an estimated $200 million to $300 million in assets, including WETH and stablecoins. In response, Aave froze rsETH markets on V3 and V4 in an effort to contain further damage.
Even so, the impact had already spread through the protocol. Aave’s total value locked reportedly fell by billions of dollars in a matter of days as users rushed to react. Core markets including ETH, USDT, and USDC hit 100% utilization, leaving depositors effectively locked in. Some users turned to indirect liquidity routes by borrowing against stablecoins such as GHO, DAI, and USDe.
The episode illustrates a key structural risk in decentralized lending: a protocol can suffer significant balance-sheet stress even when the protocol itself is not directly hacked. If unbacked collateral enters through a compromised bridge and is accepted by the lending system long enough to support borrowing, the downstream result can be frozen pools, impaired withdrawals, and potentially large bad debt.
The USDC pool became the center of the crisis
USDC was one of the most closely watched pools during the fallout. Data cited from Aavescan for April 22 showed both total supply and total borrows at nearly $1.89 billion, while available liquidity had fallen below $3 million. For four consecutive days, the pool sat at around 99.87% utilization.
At the same time, the variable borrow rate was capped near 13.82%, while the supply rate was about 12.42%. In Liao’s view, that was the core issue. The post-kink rate was not punitive enough to push out borrowers who urgently wanted to retain access to stablecoin liquidity. Instead of serving as a market-clearing mechanism, the roughly 14% borrowing cost functioned more like a tolerable fee for jumping the queue.
That dynamic matters because Aave’s design depends on utilization-based rates to balance supply and demand. When those rates fail to rise fast enough during stress, borrowers may continue to occupy scarce liquidity while suppliers lose confidence and leave. The result is a self-reinforcing squeeze, especially in large stablecoin pools where users expect near-instant access to funds.
Liao says steeper rates could attract fresh supply quickly
Liao argued that sharply increasing the post-kink slope would do more than punish existing borrowers. It could also attract fresh USDC deposits by offering significantly higher yields to suppliers once rates reset. That, in turn, could restore usable liquidity within hours if market participants respond to the new incentives.
To support the idea, he referenced traditional money-market behavior, including U.S. Treasury repo and fed funds markets, where sharply rising short-end rates often help resolve temporary liquidity dislocations. In those markets, price signals move quickly to draw in capital when funding conditions tighten. His view is that Aave should behave more similarly during acute stress, rather than allowing pools to remain effectively frozen under a relatively flat emergency rate structure.
Liao also emphasized that the proposal reflects his personal analysis and should not be interpreted as official Circle policy. Still, the proposal drew immediate attention because of his position at Circle and because Circle CEO Jeremy Allaire shared it publicly on X, bringing broader visibility to the governance discussion.
Governance, bad debt, and the next steps for Aave
The wider conversation now extends beyond rate parameters. The KelpDAO incident has raised fresh concerns about how DeFi lending protocols should absorb losses when collateral is later found to be unbacked or impaired. Estimates for unrecoverable losses across Aave markets range from roughly $124 million to $230 million, depending on how losses are eventually allocated.
Aave has already published an rsETH incident report outlining possible recovery paths. Discussions are ongoing around mechanisms that could be used to absorb bad debt, including the possibility of slashing stkAAVE. That makes the current governance debate important not only as a liquidity-management exercise, but also as a test of how the protocol responds to cross-protocol contagion.
The rate proposal itself follows a practical timeline. If the Risk Steward approves the initial changes, the interim configuration could be implemented the same day. The full target setup would then require the standard five-to-seven-day governance vote. In other words, Aave may be able to move quickly on emergency pricing, while still preserving its normal governance process for more durable changes.
Market participants are also watching input from risk service providers and ecosystem stakeholders, including Llamarisk and Aave Labs. Their assessments are likely to shape whether the community views the proposal as an appropriate emergency response or as an aggressive repricing that could create new pressures elsewhere.
Market reaction and broader implications
In the days following the exploit and subsequent outflows, AAVE fell roughly 20% to 26%, reflecting investor concern over both liquidity stress and potential loss socialization. Yet some observers interpret the proposal itself as a stabilizing signal. A rapid and targeted governance response can reassure users that the protocol is capable of adapting its risk framework when market conditions change abruptly.
More broadly, the incident highlights the growing complexity of DeFi risk. Smart contract security at the lending-protocol level is only one layer. Bridge infrastructure, collateral quality, oracle dependencies, governance responsiveness, and liquidity incentives all interact. A weakness in one component can rapidly cascade into another, even if the second protocol was never directly hacked.
That is why the debate around Aave’s USDC parameters matters beyond a single pool. It touches on a larger question facing DeFi: when liquidity is scarce and trust is shaken, should protocols rely on much steeper market-based pricing to force deleveraging and attract capital, or should they seek softer intervention tools? Liao’s proposal clearly favors the former approach, betting that stronger pricing signals are the fastest path back to a functioning market.