Written by: Liam Akiba Wright
Compiled by: Chopper, Foresight News
TL;DR:
- Vitalik Buterin proposes constructing synthetic assets based on options, eliminating the automatic liquidation trigger mechanism from the underlying design of DeFi.
- The real-world significance of this design was reflected in the recent market crash: concentrated forced liquidations amplify short-term declines, evolving into systemic selling pressure across the entire market.
- Unresolved challenges remain: whether investors can tolerate asset value drift and rebalancing costs, and whether the new model might breed entirely new security vulnerabilities.
Vitalik Buterin is working to rewrite the long-established risk control logic of DeFi: the classic mechanism where a lending position is automatically liquidated by the system when the collateral price falls below the risk control threshold. On June 1st, Vitalik published an article proposing to build synthetic assets pegged to an index using options as the underlying architecture, completely removing the structure of collateralized borrowing from the native product design.
This approach no longer sets a rigid liquidation threshold; instead, it introduces a buffer-type risk: the value of a user's position will gradually deviate from the target peg price with market movements, unless the user actively rebalances the position.
The rationale for this improvement has a strong real-world reference point: the drawbacks of the old liquidation mechanism have been repeatedly exposed during extreme market conditions. On June 2nd, Bitcoin fell below $68,000, resulting in a total liquidation volume of $394 million across the market within an hour, including approximately $87 million in Ethereum-related position liquidations, with a large number of highly leveraged positions being liquidated by the system.
This flash crash occurred the day after Vitalik's article was published, serving as another wake-up call for the industry: when crowded leveraged positions encounter a rapid price drop, concentrated automatic liquidations can worsen the short-term plunge.
Currently, this proposal remains only at the theoretical research level. It will not be immediately implemented on protocols, nor is it included in Ethereum's official roadmap, and it certainly will not directly replace existing projects and mainstream stablecoins like Aave and Maker. Vitalik steps outside the conventional thinking of optimizing collateral buffers or upgrading oracle price feed speeds, questioning from the architectural foundation: during extreme market conditions, is instantaneous forced liquidation an indispensable standard for DeFi risk control?
Why Traditional Liquidation Mechanisms Exacerbate Market Stampedes
The underlying logic of the vast majority of DeFi lending products is similar: users pledge assets to borrow funds, and positions must be maintained above a specified safety line. Taking Aave's risk control rules as an example, the Health Factor measures position safety. When this factor falls below 1, liquidation is triggered: liquidators repay the borrower's debt in exchange for the collateral assets plus a liquidation bonus.
This design originally intended to ensure the platform's solvency but can easily trigger concentrated selling pressure during market crashes. Once the value of collateral like ETH plummets rapidly, users have no option to sell voluntarily; the system forces liquidation passively. Liquidators compete to close eligible positions, and the collateral may be pushed into a market already suffering from liquidity shortages.
A working paper by the Organisation for Economic Co-operation and Development (OECD) 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 notes that liquidators heavily rely on market liquidity during extreme conditions, meaning the mechanism designed to repair platform risks can also become paralyzed in environments of liquidity drought.
Past cases confirm this risk. In 2025, an anomaly in Chainlink's oracle price feed led to over $500,000 in abnormal liquidations on Euler Finance, reigniting industry debates about oracle pricing rules in weak liquidity environments. In the same year, during a deep correction in Ethereum, nearly $320 million worth of Ethereum-based lending positions were within a 20% price drop from their liquidation thresholds, with many positions on MakerDAO and Compound hovering near critical price levels.
The crux of all these issues lies in cliff-edge liquidations. DeFi indeed needs to handle insolvent positions, but the prevailing model universally waits until the price breaches a threshold to enforce a one-size-fits-all forced closure, simultaneously forcing borrowers, liquidators, oracles, and market makers to bear concentrated pressure. Savvy speculators can even closely monitor liquidation lines to precisely position short bets.
From a user's perspective, platforms rely on liquidation to protect their liquidity pools, but ordinary borrowers are often forced to sell at the most unfavorable prices. A user might have originally intended to hold Ethereum long-term, hedge cash needs, or wait out periods of extreme volatility. Once the threshold is exceeded, the system prioritizes solvency, completely ignoring the user's holding strategy.
The New Options Approach: Turning Cliff-Edge Liquidations into Gradual Value Drift
Vitalik's alternative approach starts with the definition of the underlying asset, abandoning the model of "liquidation upon position insolvency": it splits 1 ETH into two option-like assets, P and N, tied to a price index, a strike price, and an expiration date. Upon contract expiration, an oracle determines the index price, which then allocates the corresponding ETH rights between the P and N parties.
The core logic is that the combined rights of the P asset and the N asset always equate to 1 ETH. The system merely splits the ownership of the original ETH, eliminating the need to seize user collateral or forcibly close positions to cover losses, thereby removing liquidation events at their root.
Compared to collateralized stablecoins, the difference is significant. Under the traditional debt model, a user's position might seem stable until the collateral breaches the threshold, triggering immediate forced liquidation. The options architecture eliminates sudden closures, but the target value the position is pegged to will gradually drift.
To illustrate with an example: if a user wants to lock in a USD-denominated exposure around an ETH market price of $2500, they could buy options with a strike price of $1500. If ETH continues to decline and approaches the strike line, they could roll over into options with a lower strike price. If the user does not actively rebalance, the hedging effect gradually diminishes, and the position value slowly drifts away from the target. This is the core trade-off of the new model: risk is not released in a concentrated instant, but the position's value drifts gradually with the market.
Traditional liquidation hands the decision to close a position to platform rules and liquidators; the options approach transfers the rebalancing choice to users, market makers, or automated rebalancing tools.
Vitalik also acknowledges limitations in the stablecoin scenario for this approach. A small annualized value drift might be acceptable for products used to hedge future expenses or pursue relative price stability, but it is unsuitable for accounting and settlement stablecoins. Such currencies need to be pegged to $1 for payments, bookkeeping, and tax purposes and cannot tolerate continuous value deviation from the peg.
Oracle Rules Undergo Reform
Oracle optimization is a key highlight of this approach. Collateral liquidation heavily relies on real-time price feeds: platforms need instant prices to assess position risk and enable liquidators to execute. Vitalik argues that high-frequency real-time quotes increase the security difficulty for oracles, leaving insufficient time for dispute resolution processes during price anomalies.
In contrast, the options architecture delays the oracle's pricing decision until the contract's expiration date. Oracle risk still exists but is no longer coerced by instantaneous market conditions. The deferred settlement characteristic of the contracts allows projects to adopt more fault-tolerant pricing schemes, such as prediction market-style pricing, which would be completely impractical in an instant liquidation system.
Therefore, this proposal is not just a minor adjustment to stablecoins; it's a reconstruction of DeFi's overall risk control: moving away from the underlying logic that relies on instantaneous quotes to trigger irreversible liquidations. The existing liquidation mechanism easily breeds grey areas like price manipulation, MEV arbitrage, and oracle arbitrage, precisely because the clear liquidation points give speculators a trigger line to target.
The final effectiveness still depends on the specific implementation. Wrapper contracts that automatically rebalance for users can lower the barrier to entry but might also create new regularized points that experienced traders can anticipate for arbitrage. Purely local, user-run automated tools can hide rebalancing logic but introduce challenges in user experience and execution slippage. On-chain wrapper contracts driven by DAOs require rigorous rules and sufficient liquidity to avoid becoming targets for pinpoint short attacks again.
The advantage of slower oracles is built upon complementary designs, which also present challenges for developers. While price feed fault tolerance increases, the market needs sufficient depth to support users rolling over option positions, and the accompanying rules must avoid having rebalancing actions become exploitable arbitrage signals. Past oracle failures stemmed from erroneous price feeds encountering instant, enforced liquidation rules. The options approach avoids instantaneous decisions, but project teams still need to solve issues related to index maintenance, liquidity provision, and losses during extreme market conditions.
Real-World Validation Pending: Rebalancing Costs and Liquidity are Key to Success
Whether this theory can compete with traditional collateralized lending systems ultimately depends on the supporting market ecosystem. Vitalik candidly states that slippage costs are the primary concern: relying on conventional AMMs for rebalancing, repeatedly rolling over options would generate high transaction costs, especially during periods of high volatility.
He suggests that the rebalancing market requires a new market-making model, favoring market makers who passively place one-sided orders and take on long-term positions, rather than those who instantly take liquidity in the spot market. This is also a criterion for the proposal's implementation: if users avoid cliff-edge liquidations but are continuously eroded by value drift, high slippage, and cumbersome operations, then this design can only remain a theoretical paper, unfit for commercial application.
Product positioning determines its applicable boundaries. As a hedging tool or a product for pegged exposures, this logic has clear advantages. However, for a general-purpose stablecoin aiming for a full 1:1 peg to the US dollar, its shortcomings are evident: a token with continuous drift requiring periodic rebalancing represents a completely different user promise compared to over-collateralized stablecoins redeemable for fiat or traditional CDP synthetic assets.
For the Ethereum ecosystem, the significance lies in the fact that top industry designers are no longer viewing forced liquidation as an inevitable natural law of DeFi, but rather as an architectural choice that can be replaced.
The next step is to watch whether any protocol team converts the options model into a tested wrapper product, simulation program, or a live market with sufficient liquidity to complete the pending real-world validation.
Until then, it is best to interpret this proposal as a direct challenge to DeFi's breakdown mechanisms: the industry can continue trying to speed up liquidations and better provision collateral, or it can explore entirely new underlying designs that bid farewell to passive, concentrated liquidations altogether.
