Institutional DeFi adoption faces pressure amid KelpDAO fallout and rising borrowing rates

• JPMorgan analysts said a recent wave of security breaches, coupled with stagnant TVL, has contributed to an institutional slowdown in DeFi.
• The bank stated that crypto participants are shifting toward stablecoins to protect their capital.
• USDT and USDC borrowing rates on AAVE rose to 14% following the KelpDAO exploit as users sought to unwind positions.

DeFi's recent wave of consistent hacks and stalled total value locked (TVL) is weakening its institutional appeal, according to JPMorgan analysts led by Nikolaos Panigirtzoglou, in a report late Wednesday.

The recent exploit linked to KelpDAO erased roughly $20 billion from decentralized finance's TVL within days, intensifying concerns over systemic risk and institutional participation in the sector.

"Persistent security vulnerabilities and a stagnant TVL continue to limit DeFi's institutional appeal," the analysts wrote.

The fallout extended beyond the protocols directly affected, triggering outflows from liquidity pools with no direct exposure to the compromised asset.

Although DeFi's TVL has partially recovered in US Dollar terms from its 2022 decline, analysts noted it has remained largely flat when measured in ETH, suggesting limited organic growth beneath the surface. Such limited growth "raises questions about the future of DeFi and whether DeFi can achieve the organic growth needed to support broader institutional adoption."

DeFi exploits drive stablecoin demand and recovery efforts

JPMorgan analysts added that in response to recent exploits, market participants have increasingly rotated into stablecoins as a defensive move. 

The analysts likened the shift to traditional investors moving into cash during periods of uncertainty. As a result, users have favored Tether's USDT due to its deeper liquidity across centralized exchanges and its efficiency as an off-ramp during periods of on-chain stress.

"USDT appears to be the preferred flight-to-safety vehicle for rapid exits from on-chain positions," the analysts wrote.

CryptoQuant shared a similar sentiment, citing a surge in borrowing rates for USDT and USDC on Aave V3. The rise was from roughly 3.4% to 14% after the April 19 rsETH exploit, as users rushed to borrow stablecoins and unwind positions.

AAVE V3: USDT, USDC Borrow Event Amount & Borrow Rate. Source: CryptoQuant

The sharp increase reflects a classic liquidity squeeze, in which lenders' withdrawals and rising borrowing demand rapidly reduced liquidity and pushed interest rates higher. CryptoQuant added that borrowing costs remain well above pre-exploit levels, suggesting that stress in Aave's stablecoin markets has yet to fully subside.

Amid the fallout, several major protocols have stated their intentions to support Aave's coordinated rsETH relief efforts as the ecosystem works to restore market confidence.

Lido Finance has proposed a one-time, capped contribution of up to 2,500 stETH to a dedicated relief vehicle as part of a fully funded recovery package. The proposal aims to support users impacted by the hack and limit spillover across the ecosystem.

EtherFi Foundation also indicated plans to contribute 5,000 ETH to the relief vehicle, describing the move as an effort to help safeguard users and prevent bad debt from spreading across DeFi lending markets.

Likewise, Ethena said it has been participating in Aave's coordinated relief effort and working with affected parties to help restore rsETH backing.