Aave V3’s Wrapped Ether (WETH) reserve is carrying bad debt after attackers exploited KelpDAO’s rsETH liquid restaking token and used it as collateral to borrow against the lending protocol.
Solidity developer and auditor 0xQuit flagged the situation on X, warning depositors that the WETH pool is effectively impaired and that partial withdrawals may only become possible after Aave’s Umbrella backstop settles the deficit.
How Drained rsETH Created Bad Debt on Aave
The exploit started with an attacker funding wallets through Tornado Cash. Approximately 116,500 rsETH was drained from KelpDAO, totaling over $290 million.
The attacker then supplied the stolen rsETH as collateral on Aave V3 and borrowed a large volume of WETH against it.
Because the rsETH became unbacked after the drain, the resulting positions are effectively unliquidatable. This left Aave holding WETH obligations it cannot recover through normal liquidation.
“Wish I had better news but looks like WETH on aave is fucked. Withdraw if you can but likely too late,” warned 0xQuit, Solidity developer and auditor.
The rsETH markets on Aave V3 and Aave V4 have been frozen, with Aave assuring that contracts have not been exploited as this incident was only related to rsETH.
“Freezing the rsETH markets prevents new deposits and borrowing against rsETH collateral while the situation is assessed. We are reviewing information about rsETH borrows on Aave that occurred after the exploit…if the protocol accumulates bad debt from this incident, Umbrella assets can be used to offset the deficit,” Aave stated.
What Umbrella Means for WETH Depositors
Aave’s Umbrella system, which replaced the legacy Safety Module in late 2025, is designed for exactly this scenario.
Users who staked aWETH in the Umbrella vault face automatic slashing to cover the deficit.
Once the slashing cycle completes, remaining WETH suppliers should regain partial withdrawal access.
However, a full recovery is not guaranteed, and depositors may face a haircut on their positions.
The incident marks the first major real-world test of Umbrella’s automated bad debt coverage. It also raises fresh questions about the risks of whitelisting liquid restaking tokens as collateral on lending protocols.
Meanwhile, the Upshift team, offering non-custodial vaults for managing tokenized assets, have assured users that they do not have any exposure to rsETH.
“We are in touch with KelpDAO about a potential exploit of rsETH. As a precaution, the Kelp team have decided to temporarily pause deposits and withdrawals to the High Growth ETH and Kelp Gain vaults while their investigations take place. Upshift USDC, Core USDC and EarnAUSD vaults have zero exposure to rsETH. We will provide updates as we receive them from the Kelp team,” wrote Upshift.
