Vitalik Proposes a New DeFi Risk Model to Replace Flash Liquidations

Written by: Liam Akiba Wright

Compiled by Chopper, Foresight News

TL;DR

• Vitalik Buterin proposed building synthetic assets using options, eliminating the automatic liquidation mechanism from the core design of DeFi.
• The real-world significance of this design was confirmed during the recent market crash: centralized forced liquidations amplify short-term declines, evolving into systemic selling pressure across the entire market.
• Remaining challenges include whether investors can tolerate asset value deviations and rebalancing costs, as well as the possibility that the new model may introduce entirely new security vulnerabilities.

Vitalik Buterin is rethinking the long-standing risk management logic in DeFi: the classic mechanism where loan positions are automatically liquidated if collateral prices fall below a risk threshold. On June 1, Vitalik published a post proposing a synthetic asset anchored to an index, built on an options-based architecture that eliminates the collateralized lending structure entirely within the product’s native design.

This approach eliminates rigid liquidation thresholds, replacing them with a buffer-style risk: a user’s position value will gradually deviate from the target anchor price unless they actively rebalance.

This improved logic is strongly grounded in real-world observations: the flaws of the old liquidation mechanism have repeatedly surfaced during extreme market conditions. On June 2, when Bitcoin dropped below $68,000, total market-wide liquidations reached $394 million within one hour, including approximately $87 million in Ethereum-related positions, as numerous highly leveraged positions were forcibly closed by the system.

This flash crash occurred right after Vitalik’s post, serving as a wake-up call to the industry: crowded leveraged positions combined with a rapid price drop can exacerbate short-term declines through concentrated automatic liquidations.

This proposal remains at the theoretical research stage—it will not be immediately implemented on any protocol, is not included in Ethereum’s official roadmap, and will not directly replace existing projects such as Aave or Maker or mainstream stablecoins. Vitalik moves beyond conventional approaches like optimizing collateral buffers or improving oracle update speeds, and instead questions the fundamental architecture: Under extreme market conditions, must instant forced liquidation remain a standard feature of DeFi risk management?

The underlying logic of most DeFi lending products is similar: users pledge assets to borrow funds, and their positions must remain above a specified safety threshold. For example, under Aave’s risk management rules, health factor measures position safety; if the factor drops below 1, liquidation is triggered—liquidators repay the borrower’s debt in exchange for the collateral plus a liquidation bonus.

This design is intended to safeguard the platform’s solvency, but it can trigger concentrated selling pressure during sharp market declines. When collateral such as ETH drops rapidly, users have no option to sell independently, forcing the system to liquidate positions passively. Liquidators compete to close eligible positions, potentially flooding markets that are already experiencing low liquidity.

An OECD working paper on decentralized finance (DeFi) liquidations found a positive correlation between liquidation activity and post-liquidation price volatility in major decentralized liquidity pools. The report also noted that liquidators heavily rely on market liquidity during extreme market conditions, meaning that this mechanism designed to mitigate platform risk becomes ineffective in environments of liquidity scarcity.

Past cases have demonstrated this risk. In 2025, an abnormal Chainlink oracle price triggered over $500,000 in improper liquidations on Euler Finance, reigniting industry debate over oracle pricing mechanisms in low-liquidity environments; the same year, during a sharp Ethereum price correction, nearly $320 million in Ethereum-based lending positions were within just 20% of liquidation thresholds, with numerous positions on MakerDAO and Compound stuck at critical price levels.

The root of all problems lies in cliff-edge liquidations. While DeFi does need to handle insolvent positions, the current model commonly waits until prices breach a threshold before triggering an all-or-nothing forced liquidation, simultaneously pressuring borrowers, liquidators, oracles, and market makers. Savvy speculators can closely monitor the liquidation line and strategically position short trades.

From the user’s perspective, the platform relies on liquidations to safeguard the reserve pool, but ordinary borrowers are often forced to sell at the worst possible prices. Users may have originally intended to hold Ethereum long-term to hedge against cash needs or to wait out periods of extreme price volatility. Once the threshold is exceeded, the system prioritizes solvency above all else, completely disregarding the user’s持仓 plan.

Vitalik’s alternative approach starts by defining the underlying asset, abandoning the model of liquidation when a position becomes insolvent: one ETH is split into two types of option-like assets, P and N, linked to a price index, strike price, and expiration date. After the contract expires, an oracle determines the index price, and the corresponding ETH entitlements are allocated to the P and N parties.

The core logic is that the sum of P assets and N assets always equals one ETH. The system merely splits the ownership of existing ETH, eliminating the need to seize user collateral or force liquidations to cover losses, thereby removing liquidation events at their source.

Significantly different from collateralized stablecoins: under the traditional debt model, users may appear to have stable positions, but if collateral falls below the threshold, they face immediate liquidation; under the options structure, there is no sudden liquidation, but the target value of the position gradually drifts.

For example, if a user wants to lock in a USD-denominated exposure when ETH is trading around $2,500, they can buy a put option with a strike price of $1,500; if ETH continues to decline and approaches the strike level, they can roll into options with lower strike prices. If the user does not actively adjust their position, the hedge effect gradually weakens, and the position’s value slowly deviates from the target. This is the core trade-off of the new model: risk is not suddenly released, but the position’s value gradually drifts with market movements.

Traditional clearing entrusts the decision to close positions to platform rules and liquidators; the options solution transfers the choice of rebalancing to users, market makers, or automated rebalancing tools.

Vitalik also acknowledged that the solution has limitations in stablecoin scenarios. A small annualized value drift may be acceptable for products designed to hedge future expenses and seek relative price stability, but it is unsuitable for accounting-style stablecoins. These tokens must maintain a 1:1 peg with the US dollar for payments, bookkeeping, and tax reporting, and cannot tolerate sustained deviations from their anchor price.

Oracle optimization is a key highlight of this solution. Liquidations rely heavily on real-time price feeds: the platform needs immediate price data to assess position risk and enable liquidators to act promptly. Vitalik believes that high-frequency real-time pricing increases the difficulty of oracle security, leaving insufficient time to initiate dispute resolution procedures during price anomalies.

The options architecture defers the oracle pricing decision until the contract expiration date; while oracle risk still exists, it is no longer subject to immediate market pressure. The contract’s deferred settlement feature allows projects to adopt more fault-tolerant pricing mechanisms, such as prediction market-based pricing, which would be entirely impractical in an instant-cash settlement system.

Therefore, this solution is not merely an adjustment to stablecoins, but a fundamental restructuring of DeFi’s overall risk management: moving away from the underlying logic that triggers irreversible liquidations based on instantaneous price quotes. The current liquidation mechanism easily fosters gray areas such as price manipulation, MEV arbitrage, and oracle arbitrage—the root cause being that the clearly defined liquidation point provides speculators with a precise trigger to target.

The final outcome still depends on the specific implementation. An automated smart contract that rebalances users' portfolios on their behalf can lower the barrier to entry but may also create new predictable patterns that experienced traders can anticipate and arbitrage; purely local user automation tools can conceal rebalancing logic but introduce challenges in user experience and trade slippage; a DAO-driven on-chain encapsulated contract requires strict rules and sufficient liquidity to avoid becoming yet another target for定点做空.

The advantages of a slow oracle are built upon complementary design elements, which also represent the key challenges for developers. While the tolerance for quote errors is increased, the market requires sufficient depth to support user rotation of option positions, and accompanying rules must prevent rebalancing actions from becoming exploitable arbitrage signals. Past oracle failures fundamentally occurred when incorrect quotes triggered immediate liquidation rules; although the options framework avoids instantaneous decisions, project teams must still address index maintenance, liquidity provision, and losses during extreme market conditions.

Whether this theory can compete with the traditional collateralized lending system ultimately depends on the supporting market ecosystem. Vitalik explicitly identified slippage loss as the primary risk: rebalancing through conventional AMMs and repeatedly cycling through options generates high transaction costs, especially during periods of extreme volatility.

He proposed that the rebalancing market requires a completely new market-making model—one that favors passive, one-sided orders and long-term order absorption by market makers, rather than immediate trade execution in spot trading. This is also the benchmark for implementing the solution: if users avoid cliff-like liquidations but gradually erode their principal due to value drift, high slippage, and cumbersome operations, then this design can only remain theoretical and fail to achieve commercial deployment.

Product positioning determines the applicable scope. As a hedging tool or an asset class exposure product, this logic has clear advantages; however, if designed as a general-purpose stablecoin pegged 1:1 to the US dollar, its shortcomings are evident: tokens that continuously drift and require periodic rebalancing carry fundamentally different user commitments compared to over-collateralized stablecoins redeemable for fiat or traditional CDP synthetic assets.

For the Ethereum ecosystem, this signifies that industry-leading designers no longer view forced liquidation as an unavoidable natural rule of DeFi, but rather as a replaceable architectural choice.

Next, monitor whether any protocol teams will convert the options model into a tested, packaged product, simulation, or live market with sufficient liquidity to enable validation.

Before this, it is best to interpret this proposal as a direct challenge to DeFi’s liquidation mechanism: the industry can either continue trying to accelerate liquidations and improve collateral provision, or explore entirely new underlying designs that move away from passive centralized liquidations altogether.