Understanding ERC-4626 in one article: The new standard for DeFi tokenized insurance vaults.

Original author: Sina Pilehchiha

Translated by: Deep Tide TechFlow

TLDR: ERC-4626 is a standard for tokenizing insurance vaults.

Before the introduction of ERC-4626, each insurance pool had its own specifications and implementation details. This made integration difficult, error-prone, and wasteful of resources.

ERC-4626 aims to solve this problem through standard specifications, reducing integration workload and creating more consistent and powerful implementation patterns, just like ERC-20.

What is ERC-4626?

ERC-4626 is a standard that improves the technical parameters of a profit-sharing insurance pool. It provides a standard API for a profit-sharing insurance pool that represents a single underlying ERC-20 token share.

Tokenized insurance pools have become a very common pattern in DeFi. Many dApps such as yield aggregators, lending markets, and staking derivatives utilize and rely on tokenized insurance pools. Examples of tokenized insurance pools include Yearn and Balancer. As a yield aggregator, Yearn's insurance pool allows users to deposit digital assets and earn yield. Balancer is an automated portfolio manager and liquidity provider, with its core business logic relying on the insurance pool. These insurance pools manage tokens in various pools, while separating token management from the logic of the pools themselves.

The protocol enhances liquidity and flexibility by tokenizing its insurance pool. Tokenized insurance pools can be easily traded and used as assets on DeFi platforms. Additionally, they can create diverse and interconnected financial products. This paradigm, often referred to as "Money Legos," has been advocated by the industry.

However, the lack of proper adaptability or standardization can bring challenges. It not only makes it difficult for developers to comply with industry standards such as ERC-20, but also confuses new developers. Without proper adaptability or standardization, it is difficult to review new changes and verify the implementation details of integration.

Therefore, ERC-4626 was proposed to address this issue, simplifying integration and allowing DeFi participants to ultimately adopt a more secure and powerful unified insurance protocol. This, in turn, will reduce the attack surface that the protocol may be vulnerable to, while integrating tokens across multiple protocols.

ERC-4626 can prevent which security issues?

By providing a unified standard, ERC-4626 accelerates the speed of cross-protocol integration. Familiar and unified standards also make it easier for developers to understand, reducing the possibility of coding errors. This helps prevent composability issues. Standardization can also prevent duplicate work, as the community only needs to design an insurance library once, rather than designing separately for each protocol. As this design work is often prone to errors, it helps avoid repeating design flaws that have already been established but are commonly present.

We will introduce two case studies here to demonstrate what problems ERC-4626 can prevent.

Rari Capital Incident

Rari Capital has been stolen tokens worth about $11 million, which is equivalent to 60% of all user funds in the Rari Capital Ethereum pool.

Overall, the hack of Rari Capital was due to an insecure cross-protocol implementation. Its Ethereum pool utilized the Alpha Finance ibETH token contract as an output strategy by depositing ETH into it. This specific strategy tracks the value of its ibETH/ETH exchange rate through certain contracts and formulas (such as the ibETH.totalETH / ibETH.totalSupply function), which may result in incorrect outputs in this attack scenario. For example, the debt value may be artificially inflated when calling the ibETH.work() function.

Attackers only need to repeatedly call the deposit and withdraw functions in the RariFundManager contract to drain the Rari Fund Manager. The deposit and withdraw functions need to obtain the balance of the pool to calculate the number of REPT tokens to be issued to the caller or the amount of ETH to be distributed to the caller. This operation will respectively call the getBalance function of the Alpha pool, call the ibETH contract and its totalETH function. Rari is unaware of the possibility of manipulating this function.

There is another function in the ibETH contract called ibETH.work. This function can call any contract specified by the user. This allows Rari's deposit and withdraw functions to become reentrant and be called multiple times.

The work function is a payable function, which means that users can control the amount of ETH in the ibETH contract through the work function, thereby changing the value returned by the totalETH function. To make matters worse, the work function also supports calling any other contract, such as RariFundManager.

Through this function, attackers can send ETH again and increase the totalETH amount in the ibETH contract, while calling the withdraw function in the RariFundManager contract to redeem more assets.

This incident highlights the significant risks posed by inadequate integration and incompatible design in DeFi contracts. It emphasizes the importance of standards like ERC-4626 in preventing such attacks by adding critical layers of security and predictability, and promoting unified behavior and mutual understanding.

Cream Finance Incident

ERC-4626 Potential Security Risks

EOA Direct Access

If you want to directly access a vault, its implementation needs to have the ability to accommodate slippage losses or unexpected deposit/withdrawal restrictions. Unlike smart contracts, EOA does not have a transaction rollback fault protection mechanism, and if precise output is not achieved when calling core functions, it cannot be rolled back.

Extension Insurance Vault

As more and more participants adopt the ERC-4626 standard, we will see more extensions implemented for this standard. For example, Superform has developed an experimental Multi-Insurance Library extension that supports the use of different computations within a single insurance library contract. Naturally, the further the implementation deviates from the original standard, the higher the possibility of introducing new vulnerabilities. Developers and auditors can find their best options based on use cases to determine the actual risk value.

Please note that it is not the smallest addition of each protocol that causes catastrophic events, but rather the sum of their integration together.

The potential attack vectors mentioned above are some of the issues that are widely discussed around the ERC-4626 standard. As adoption increases, we will certainly explore more implementation use cases, as well as more suitable scenarios for integrating with the ERC-4626 insurance library.

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