Author: Liam Akiba Wright
Compiled by: Chopper, Foresight News
TL;DR
- Vitalik Buterin proposes building synthetic assets based on options, fundamentally removing the automatic liquidation trigger mechanism from DeFi's design.
- The real-world relevance of this design is confirmed by the recent market crash: concentrated forced liquidations amplify short-term declines, evolving into systemic selling pressure across the entire market.
- Unresolved challenges remain, such as whether investors can tolerate asset value drift and rebalancing costs, and whether the new model may breed entirely new security vulnerabilities.
Vitalik Buterin is working to rewrite the long-standing risk control logic in DeFi: the classic mechanism where lending positions are automatically liquidated by the system when collateral price falls below a safety threshold. On June 1st, Vitalik published an article proposing to build synthetic assets pegged to an index with options as the underlying architecture, completely removing the collateralized lending structure from the product's native design.
This approach eliminates the rigid liquidation red line, replacing it with a buffer-type risk: the value of a user's position will gradually drift away from the target peg price as the market moves, unless the user actively rebalances.
This improvement logic has a strong real-world reference: the drawbacks of the old liquidation mechanism have been repeatedly exposed in extreme market conditions. On June 2nd, Bitcoin fell below $68,000, with liquidation volume across the entire market reaching $394 million within an hour, including approximately $87 million in Ethereum-related position liquidations. A large number of highly leveraged positions were liquidated by the system en masse.
This flash crash occurred the day after Vitalik's article, also serving as a wake-up call for the industry: crowded leveraged positions combined with a rapid price drop can turn concentrated automatic liquidations into a catalyst that worsens the short-term plunge.
The proposal is currently only at the theoretical research stage; it will not be immediately implemented on a protocol, nor is it part of the official Ethereum roadmap, and it will not directly replace existing projects like Aave, Maker, or mainstream stablecoins. Vitalik goes beyond conventional thinking of optimizing collateral buffers and upgrading oracle price feed speed, questioning from the architectural foundation: during extreme market conditions, is instantaneous forced liquidation necessarily the standard for DeFi risk control?
Why Traditional Liquidation Mechanisms Exacerbate Market Crashes
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 threshold. Taking Aave's risk control rules as an example, a Health Factor measures position safety; when it falls below 1, liquidation is triggered: a liquidator repays the borrower's debt in exchange for the collateral plus a liquidation bonus.
This design was intended to ensure the platform's solvency but can easily trigger concentrated selling pressure during sharp market declines. Once collateral like ETH plummets rapidly, users lose the right to sell autonomously, and the system initiates forced liquidations. Liquidators compete to close eligible positions, potentially pushing the collateral into a market already suffering from a liquidity shortage.
An OECD working paper on DeFi liquidations found a positive correlation between liquidation activity and post-liquidation price volatility in major decentralized trading pools. The report also notes that liquidators heavily rely on market liquidity during extreme conditions; this mechanism, meant to repair platform risk, can also struggle to function in an illiquid environment.
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 debate about oracle pricing rules in low-liquidity environments. In the same year, during a deep correction in Ethereum, nearly $320 million in Ethereum-based lending positions were within a 20% price drop of their liquidation thresholds, with many positions on MakerDAO and Compound stuck at critical price points.
The crux of all these problems lies in cliff-edged liquidations. DeFi indeed needs to handle insolvent positions, but the current model generally waits until the price breaches a threshold before enforcing a one-size-fits-all forced liquidation, simultaneously forcing borrowers, liquidators, oracles, and market makers to bear concentrated pressure at the same time. Sophisticated speculators can also closely monitor liquidation lines to strategically short the market.
From the user's perspective, platforms rely on liquidations to protect their capital pools, but ordinary borrowers are often forced to sell at the most unfavorable prices. Users might have originally intended to hold Ethereum long-term, hedge cash needs, or wait out severe price volatility. Once the threshold is exceeded, the system prioritizes solvency, completely disregarding 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 "liquidating a position when it becomes insolvent": it splits 1 ETH into two option-like assets, P and N, tied to a price index, a strike price, and an expiration date. At contract maturity, an oracle determines the index price, then divides the corresponding ETH rights between the P and N parties.
The core logic is that the rights of the P asset and the N asset always add up to 1 ETH. The system merely splits the original ETH ownership, eliminating the need to seize user collateral or forcibly close positions to cover losses, thereby removing liquidation events at the root.
The contrast with collateralized stablecoins is significant: in the traditional debt model, a user's position may seem stable, but if the collateral breaches the threshold, it is immediately subject to forced liquidation. The options architecture avoids sudden liquidations, but the target value the position is pegged to will gradually drift.
To illustrate, a user wanting to lock in a USD-denominated exposure around an ETH market price of $2500 could buy an option with a strike price of $1500; if ETH continues to fall towards the strike line, they could roll over to buy an option with a lower strike price. If the user does not actively rebalance, the hedging effect gradually diminishes, and the position's value slowly drifts away from the target. This is the core trade-off of the new model: risk is not released in a sudden, concentrated burst, but the position's value drifts gradually with the market.
Traditional liquidation hands the decision to close positions to platform rules and liquidators; the options approach transfers the right to rebalance back to users, market makers, or automated rebalancing tools.
Vitalik also acknowledges the limitations of the scheme in the stablecoin context. Minor annualized value drift might be acceptable for products used to hedge future expenses or seek relative price stability, but it is unsuitable for accounting or settlement stablecoins. Such currencies need to peg 1 USD for payments, bookkeeping, and tax reporting, and cannot tolerate continuous deviation from the peg.
Oracle Rules Face Transformation
Oracle optimization is a key highlight of this proposal. Collateralized liquidation heavily relies on real-time price feeds: platforms need instant prices to assess position risk and allow liquidators to execute. Vitalik argues that high-frequency, real-time quotes increase oracle security challenges, and there is insufficient time for dispute arbitration processes during price anomalies.
The options architecture defers the oracle's pricing decision until the contract's maturity date. Oracle risk still exists but is no longer pressured by instantaneous market conditions. The deferred settlement characteristic of the contracts allows projects to adopt more fault-tolerant quoting schemes, such as prediction market-style feeds, which are completely impractical in an instantaneous liquidation system.
Therefore, this proposal is not merely a tweak to stablecoins but a reconstruction of DeFi's overall risk control: moving away from the foundational logic that relies on instantaneous quotes to trigger irreversible liquidations. The existing liquidation mechanism easily breeds gray areas like price manipulation, MEV arbitrage, and oracle arbitrage, largely because clear liquidation points give speculators a trigger line to target.
The final outcome still depends on the specific implementation. Wrapper contracts that automatically rebalance for users can lower the barrier to entry but may also create new, predictable points that sophisticated traders could arbitrage. Pure, local user automation tools could hide rebalancing logic but introduce usability and execution cost challenges. DAO-driven on-chain wrapper contracts would require rigorous rules and sufficient liquidity to avoid becoming targets for precision shorting again.
The advantage of slower oracles depends on the accompanying design, which is also a challenge left for developers. While fault tolerance in price feeds increases, the market needs sufficient depth to support users rolling over their option positions, and supporting rules must avoid letting rebalancing actions become exploitable arbitrage signals. Past oracle failures were essentially a combination of incorrect price feeds meeting instantly enforceable liquidation rules; the options approach avoids instantaneous decisions, but project teams still need to solve problems like index maintenance, liquidity provision, and losses during extreme market moves.
Practical 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 explicitly states that slippage is the primary concern: relying on regular AMMs for rebalancing, repeatedly rolling over options would incur high transaction costs, especially during periods of high volatility.
He suggests that the rebalancing market needs a new market-making model, favoring passive, one-sided order placement and long-term liquidity provision over instant order-taking spot trading. This is also a criterion for the scheme's practical 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, unsuitable for commercial deployment.
Product positioning determines its applicable scope. As a hedging tool or a product for pegged exposures, this logic has clear advantages; but as a general-purpose stablecoin aiming for a full 1 USD peg, its shortcomings are evident: a token with continuous drift and periodic rebalancing offers 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 no longer view forced liquidation as an unavoidable, natural rule of DeFi, but rather as an architectural choice that can be replaced.
The next step is to watch whether any protocol team transforms the options model into a tested wrapper product, simulation program, or live market with sufficient liquidity to complete practical validation.
Until then, it's best to interpret this proposal as a direct challenge to DeFi's collapse mechanisms: the industry can continue trying to speed up liquidations and provide better collateral, or it can explore entirely new foundational designs that bid farewell to passive, concentrated liquidations.
