On December 4th, 2022, Sherlock was informed by M11 Credit that Orthogonal Trading would be unable to repay their loans
Sherlock currently has 5M USDC deposited into the non-permissioned USDC Maple pool managed by M11 Credit
Sherlock has been preliminarily advised that this pool will see ~20-25% recovery, meaning a loss of ~4M USDC for the Sherlock staking pool
Based on the current ~11.5M USDC staking pool, Sherlock expects stakers to lose 33%-35% of capital due to this event
Sherlock deposited 5M USDC into Maple on August 31st, 2022. This came after many discussions with the M11 credit team over the summer about the pool and its performance after the UST/Luna blowup and 3AC/Celsius/Voyager/BlockFi issues. The pool had taken no losses from any of those events, and in late August Sherlock agreed with M11 Credit's assessment that the contagion was mostly over. Obviously, the FTX situation last month proved that Sherlock was very wrong about this.
Sherlock deposited 5M USDC of the staking pool (at that time it was targeted to be a 20M USDC staking pool) into M11 Credit's USDC pool, which had a stellar track record of no losses and good returns.
As confirmed by M11 Credit, the day after Sherlock deposited 5M USDC, Orthogonal made up only 14% of loans in the pool. By December 3rd, 2022, around the time Sherlock’s 90-day lockup in the Maple pool was ending, Orthogonal made up ~82% of the loans in the pool. The increase in Orthogonal’s share of the pool from 14% to around 82% is one of the main reasons why the losses at Sherlock are so large.
Despite offering a 20% APY through most of September, Sherlock's pool did not hit the 20M USDC target. It stayed closer to 10M USDC (and is currently still around 11.5M USDC). Because of this, Sherlock's plan to stake 5M USDC into Maple, 5M USDC into TrueFi, 5M USDC into Aave, and 5M USDC into Compound had to change. Because the 5M USDC in Maple was subject to a 90-day lockup, Sherlock did not stake any money into TrueFi in order to maintain a 50/50 ratio of CeFi lending strategies to DeFi lending strategies (Aave, Compound). So Sherlock ended up with the desired 50% target of CeFi lending strategies, but they were all in Maple instead of split between Maple and TrueFi. This obviously increased Sherlock’s desired exposure to Maple.
When the FTX blowup occurred, Sherlock wanted to remove funds from Maple (due to the increased CeFi risks) but the 90-day lockup had not expired.
It wasn't until the announcement from M11 Credit about Auros (which Sherlock did not have any exposure to because it was in the M11 Credit WETH Maple pool) on November 31st, 2022 that Sherlock activated the 10-day cooldown to remove funds from Maple. Sherlock is currently 6 days into that cooldown period right now.
M11 Credit was concerned about Sherlock’s move to activate the cooldown, so members of Sherlock and M11 Credit spoke on December 1st, 2022 and M11 Credit messaged that the Auros situation in the WETH pool was misunderstood and less worrying than it seemed. They also messaged that the USDC pool was unaffected by the Auros situation and was in perfectly good standing and that they were in contact with all borrowers in the USDC pool. Of course, Sherlock still had 9 more days to go in the cooldown period, so there was nothing to be done until then.
On December 4th, 2022 (yesterday), M11 Credit asked to get on another call. They explained that they learned on December 3rd, 2022 that Orthogonal Trading had a massive hole in its balance sheet. They explained that Orthogonal had given them assurances after the FTX situation that they had only a small (~$2.5M) loss due to FTX and were fine. M11 Credit thinks Orthogonal severely misrepresented their financial situation and they are weighing all options for legal recourse. However, the events of December 4th, 2022 didn’t matter much because Sherlock was still 5 days away from the cooldown ending, so there was no action to take. And there was no cash left in the Maple pool that Sherlock could draw on even if the cooldown had already ended.
The situation is still fluid, but Sherlock has been told that a 20-25% recovery is likely for depositors in the pool. This would mean Sherlock recovers 1M-1.25M USDC of the 5M USDC deposited. This would result in a 3.75-4M loss for stakers, who make up ~11.5M USDC of capital currently. On a percentage basis, it would mean a loss of around 33-35% for Sherlock stakers. But there is a good chance this estimate may increase or decrease as more information comes to light.
Unfortunately, Sherlock is not in a financial position to compensate stakers for this loss if Sherlock wants to continue operations otherwise.
Sherlock will continue to push forward on the mission.
The exact details of how to do that may change. Sherlock has been exposed to a variety of CeFi risks (Maple, USDC, etc.) and that may not be the right path forward from here. The Sherlock protocol also has the ability to direct staking pool funds to various DeFi protocols through integrations. It’s unclear whether Sherlock is the correct protocol to be doing this. Sherlock is still finding its identity when it comes to its place in the ecosystem, but it’s becoming clearer that Sherlock should have as little exposure to centralized entities as possible, and that Sherlock should delegate capital allocation elsewhere, potentially back to stakers themselves.
Sherlock is not going anywhere. There will be a lot of pain for a very long time due to this event. Some people will never forgive Sherlock. And surely the reputation of Sherlock will be tarnished because of this. But many Sherlock stakeholders don't believe it will be tarnished in an irrecoverable way. Sherlock has done a lot of good things and kept a lot of protocols protected in the last year, and it’s unclear who else would be pushing the Web3 security space forward in these ways.
Sherlock still believes that DeFi can have one of the greatest positive impacts on the world. Sherlock still believes that DeFi can save millions of people from destitution because of being forced to hold a certain currency. And Sherlock still believes that, in order for DeFi to be successful, someone will need to take the risks of smart contract hacks away from the average user. Sherlock believes it is best positioned to accomplish that, and doesn’t trust anyone else to get it done.
Sherlock apologizes for this terrible outcome and for the decisions that allowed it to occur. Sherlock will share more details about this event as they become available. Please reach out to contact@sherlock.xyz or in the Sherlock Discord with any questions or concerns.
Official statement from M11 Credit
Official statement from Maple
Maven 11 has been a staker/supporter in the Sherlock staking pool since September 2021.