Talking about the security, income and risk control of DEX liquidity pool from the HLP vault incident

Hyperliquid Vault Loss Event

Event Overview: On March 12, 2025, Hyperliquid Treasury (Hyperliquidity Provider) suffered a short-term loss of more than $4 million. This loss was caused by a whale using 50x leverage who took the initiative to liquidate his position when the ETH price fell, resulting in the liquidation of long orders of up to 160,000 ETH (worth about $306 million). Due to the huge amount, the ETH price continued to fall during the liquidation process, further expanding the loss, and the Hyperliquid Treasury eventually borne this part of the loss.

Security and risk control are always important topics for all exchanges, and this HLP incident has sounded the alarm for us. As a DEX employee, I would like to talk about the DEX vault from the two aspects of protocol mechanism and risk management.

What is a DEX vault

DEX vaults are generally divided into single vaults and composite vaults. Single vaults are an innovative architectural design that aims to improve capital efficiency and user experience through centralized management and optimized asset use. As a smart contract system, single vaults centrally store and manage all user assets, allowing users to deposit all assets in a unified contract to avoid repeated authorization and transfer of assets between multiple protocols. By reducing unnecessary token transfers and multiple approval operations, Gas fees can be effectively reduced. Assets in the vault can be used for multiple purposes at the same time, such as providing flash loans, participating in Yield Farming, or as liquidity for AMM.

In addition to the literal meaning of allowing users to deposit assets, the single vault also has a function similar to a "Lego base", similar to a decentralized "app store". Developers can build a variety of DeFi applications on this flexible underlying architecture. The core advantage of this model lies in its modular design, which allows developers to focus on the development of application logic and entrust the underlying token management and accounting to the vault. This separation allows developers to build complex functions more efficiently without having to design the underlying asset management system from scratch.

In traditional DeFi protocols, each application usually needs to manage its assets independently, which not only increases development costs, but may also lead to asset fragmentation and inefficient use of funds. The single vault provides a shared pool of funds for multiple applications by centrally managing assets. This design allows developers to easily build multiple applications such as lending, liquidity mining, and yield optimization on it without worrying about the storage and management of the underlying assets.

The earliest single vault can be traced back to March 2021, when SushiSwap released its single vault BentoBox. BentoBox allows developers to build applications such as lending protocols such as Kashi and leveraged trading tools on it, and these applications can share assets in the vault to achieve higher capital efficiency. Since the vault's smart contracts have been rigorously audited and tested, it not only lowers the threshold for the development of ecological applications, but also further improves the overall security of the protocol.

Another important function of a single vault is to support synergy between multiple DeFi applications. By centralizing all assets in one vault, different dapps can connect to each other and share assets, forming a strong network effect. Let's take Balancer 's V2 vault as an example. Developers can freely build a variety of AMM (automated market maker) strategies to use idle assets in the vault for farming or lending. Some traders even use a single vault for flash loans and arbitrage. Arbitrageurs can quickly switch between different funding pools. The efficient funding liquidity model will further amplify the scale of benefits.

The HLP vault that suffered losses in this news event is strictly speaking a composite vault composed of multiple strategy modules. Its main structure is divided into four parts: market making, order acceptance, funding rate and transaction settlement.

Market making strategy, which calculates a fair price based on quote data from DEX and large centralized exchanges. The vault executes trades around this fair price, running order-making and order-taking strategies, with the goal of providing 24/7 profitable liquidity as soon as all assets are listed. Although the strategy runs off-chain to maintain speed and efficiency, the positions held by the vault, unfulfilled orders, transaction history, deposits and withdrawals are visible in real time on the chain.

The market making strategy of the Treasury not only provides traders with depth and liquidity, but also reduces slippage by optimizing quotes and order management. Community members (including institutions and retail investors) participate in market making by adding liquidity, thereby earning market maker profits. This model makes the DEX Treasury not only a passive liquidity provider, but also an active market participant.

Taking orders is a strategy that actively seeks profitable trading opportunities based on market dynamics and order book depth. It analyzes buy and sell orders on the order book and chooses to execute trades at the appropriate price level to earn the bid-ask spread. This strategy is similar to the role of "Taker" in traditional trading, that is, actively taking orders rather than passively placing orders.

The order-taking strategy and market-making strategy complement each other. The market-making strategy maintains the depth and stability of the order book by providing liquidity, while the order-taking strategy captures short-term profits brought by market fluctuations through active trading. This synergy allows the vault to flexibly adjust its strategy under different market conditions and maximize profits.

Funding rate, in the perpetual contract market, the funding rate is a mechanism used to adjust the cost of long and short positions. The Treasury provides an additional source of income for the platform by participating in the collection of funding rates. When there are too many positions in one direction in the market, the funding rate will become higher, and the Treasury can earn this part of the fee by providing liquidity in the opposite direction. This mechanism not only helps DEX to obtain income, but also balances the long and short positions in the market by adjusting the funding rate, thereby maintaining market stability.

Liquidation strategy, like market making, is always the two most stable ways to make money in DEX trading. The Treasury naturally takes on the responsibility of handling liquidation operations on the platform. When a user's position is facing liquidation due to insufficient margin, the Treasury will take over these positions to ensure the healthy operation of the platform. (This is also the crux of the HLP incident, which I will explain in detail below.) By participating in liquidation, the Treasury can not only obtain liquidation income, but also further optimize its overall risk exposure by managing liquidation positions.

Through the above four strategies, the composite vault provides strong liquidity support and revenue sources for DEX platforms. These strategies not only improve the overall efficiency and stability of the platform, but also provide users with low-volatility, high-yield investment opportunities. Therefore, not only Hyperliquid, but also multiple DEXs such as Antarctic Exchange currently use such vault design.

Risk Management of DEX

Now let's review what happened to HLP. A trader converted 10 million USDC into a $271 million long position in ETH through high leverage, and then withdrew the collateral, forcing HLP to take over the transaction. The trader ultimately made a profit of $1.8 million, while HLP suffered a loss of $4 million.

This perfectly utilizes the liquidation strategy we mentioned above. If the trader trades directly through the orderbook market price, he will face huge slippage losses, but he is very "smart" to withdraw the collateral, forcing Hyperliquid to liquidate its position in disguise. HLP has to bear up to $286 million in ETH long exposure. This trader can immediately open a reverse short position on other exchanges to hedge and profit from the short position.

Why did Hyperliquid lose as much as 4 million? It turned out that when the trader completed the collateral withdrawal, HLP was forced to take over the 290 million position. Under such high pressure, the protocol could only quickly match transactions. Due to the limited market depth, huge slippage was inevitable. Of course, Hyperliquid also made up for the loss in time, and the maximum leverage of BTC and ETH was reduced to 40 times and 25 times respectively, and the margin threshold for large positions was increased.

Since the vault liquidation strategy must passively take over the user's position to maintain the stability of the protocol when the user withdraws the collateral, some professional DEXs will take additional measures to maintain market stability when there are abnormal price fluctuations and extreme market conditions. For example, Antarctic Exchange 's dynamic risk control mechanism, AX (Antarctic Exchange for short) has designed a trader's trading risk limit, divided into different gears according to the user's trading volume, and then controlled the overall risk of the exchange according to different gears.

If the market fluctuates violently, AX will reduce the risks that the exchange may face by adjusting the maximum leverage multiple of the trader's open position or maintaining the margin ratio. Moreover, this mechanism is dynamic and is adjusted by the risk control module within the protocol according to market conditions. This not only ensures the security and stability of DEX, but also maximizes the retention of users' enthusiasm and passion for the market. Thanks to this mechanism, Antarctic Exchange's current LP income has reached 32.72%.

Summarize

Through this Hyperliquid vault incident, we can deeply understand the complexity and importance of DEX liquidity pools in terms of security, income and risk control. The composite vault provides strong liquidity support and income sources for the platform through multiple strategy modules (such as market making, order acceptance, funding rate and liquidation). However, this complex structure also increases the possibility of risk exposure under extreme market conditions.

The HLP incident revealed the huge risks that liquidation strategies may bring in extreme cases. When artificial fluctuations occur, passive positions may lead to huge slippage losses. Therefore, DEX platforms need to pay more attention to the design of risk control mechanisms.

In the context of the rapid development of the DEX industry, security and risk control are always core issues. This incident reminds us that whether it is a single or complex vault, it is necessary to continuously optimize risk control strategies while pursuing high returns.

Only through strict smart contract audits, reasonable strategy design, and dynamic risk management mechanisms can DEX platforms achieve sustainable revenue growth while ensuring the safety of user assets. In the future, the DEX industry needs to continue to explore more efficient and secure vault architectures and risk management solutions to cope with increasingly complex market environments and potential risks.