It’s been widely reported that crypto investors lost more than $350 million earlier this week, as their leveraged positions were closed on various decentralized finance (DeFi) exchanges following a steep drop in Ethereum’s (ETH) price to as low as $2,190 per coin.

While Ethereum’s price has rebounded back above $2,400 at the time of writing, according to CoinGecko.com, its domino downing-price damage had been done. Hundreds of investors had been liquidated or “rekt” - crypto shorthand for wrecked - while the total value locked on all DeFi platforms had fallen nearly 30% in the span of a week.

How AAVE Was a Loser…But More of a Winner

Throughout the chaotic sell-off, it’s reported that crypto DeFi token Aave (AAVE) lost almost 24% of its market cap. And yet because Aave is a preferred DeFi lending platform for many investors who want to borrow to try and lever up their investment amounts, Aave made more than $6 million in a single night as it closed and sold off collateral of investors who lost their respective bets.

Aave founder Stani Kulechov posted to his more than 248,000 followers on X, formerly Twitter, that this marked a significant win for his protocol and DeFi overall.

Aave Protocol withstood market stress across 14 active markets on various L1s and L2s, securing $21B worth of value.

Aave Treasury was rewarded with $6M in revenue overnight from decentralized liquidations for keeping the markets safe.

While the crypto space avoided a sector-wide meltdown, with DeFi holding off collapse within its niche as well, critics assert that DeFi has systemic issues that keep it from doing better.

Is Regulation the Only Way to Fix DeFi?

A recently published white paper from the folks over at KPMG titled DeFi and the Decentralization Illusion states that the DeFi ecosystem is built almost exclusively on the Ethereum blockchain. It’s not a surprise to anyone that the ETH blockchain operates on a PoS consensus model that allows its validators to decide the transactions that get fulfilled and when, which the authors assert is not truly decentralized.

The paper was also critical of opacity within the DeFi liquidation process overall; high collateral requirements for leverage, which are often as much as 100% of the loan amount; as well as a system that favors sophisticated trading bots that outmaneuver average investors with millisecond trading transactions.

The white paper concludes that the only solution to improve DeFi is through regulatory safeguards that protect investors. But that’s not the only solution.

Controlled Auctions for Liquidated Accounts

An alternative option to reimagine some of the issues facing DeFi’s current status quo, while avoiding onerous overregulation, might be found in controlled auctions. Currently, this particular option seems to only be available on the Pyth Network via its Express Relay feature.

Express Relay is an oracle-agnostic program that has the capabilities to auction off valuable transactions — such as liquidations — to a network of top searchers on a given platform or exchange. The auction model ensures access to a highly competitive pricing process, while eliminating interference from network miners or validators.

Benefits of Controlled Liquidation

Hypothetically speaking, the recent $350 million DeFi collapse would have played out quite differently. Here’s how the automated auction process would have shaken down if Aave had been running Express Relay during the selloff as leveraged accounts started being forcibly closed:

• Rather than the liquidation defaulting to a typical free-for-all mode, Aave would have initiated a controlled auction for the liquidation opportunity based on its predetermined specs.

• Parties interested in the distressed assets would submit bids and offering terms such as liquidation price, settlement speed, and processing fees to Aave.

• Aave would then have selected the winner using a predefined criteria grid to remove guesswork and ensure transaction speed. The grid would take into account variables such as the highest bid, fastest execution time, or lowest liquidation price.

• The Express Relay software would automatically manage the technical and transactional aspects of the auction, ensuring the winning bid was executed efficiently.

On paper, a controlled auction avoids the chaotic hurly burly typically associated with a market liquidation event. It also addresses a handful of inefficiencies that would be unavoidable under the typical liquidation model, specifically:

• Fairness: A controlled auction addresses some of the more pointed criticisms about DeFi being a playground for tech-savvy traders who profit at the expense of average investors.

• Efficiency: It makes the sell-off process more orderly, potentially leading to better outcomes for borrowers and lenders.

• Transparency: The auction process creates a new window of transparency as to how liquidations could be handled.

• Resilience: Empowering protocols such as Aave with greater control and planning in advance regarding such impactful events, enables them to endure and bounceback faster from severe market shocks.

Controlled auctions aren’t the panacea for all of DeFi’s problems, but they demonstrate a step forward regarding a critically important need where DeFi has obvious room for improvement. Innovation such as this is another proof point that DeFi isn't just replicating traditional finance on the blockchain, but is charting a new path forward toward a more equitable and efficient financial system.