ERC-7265: a detailed exploration of its impact on DeFi and Ethereum

You might not have heard about Elon Musk’s new child ERC 7265…joking aside, actually this is a new proposed standard for the DeFi ecosystem. But first, let’s do some house cleaning. ERC is an abbreviation for Ethereum Request for Comments, which is the network’s official protocol for proposing updates, improvements or changes.

The ERC 7265 standard outlines a proposed so-called circuit breaker, that can stop the transfer of tokens when a cyber attack is suspected or identified. This should make the DeFi (or decentralized finance) applications on the Ethereum network safer and more impervious to token outflows most attacks target.

This measure is essentially a circuit breaker contract, which when executed tells the network to pause token outflows to mitigate hacks.

ERC 7265: what it means for DeFi security and Ethereum

The importance of security in DeFi

ERC-7265: a detailed exploration of its impact on DeFi and Ethereum - 3f51705e b1f8 4344 909b 4d263b3359d8

If you’ve read any of our previous articles about Ethereum then you know that it offers a smart contract interface, allowing the Ethereum community to create their DApps (or decentralized apps), including decentralized finance applications.

This can include DeFi projects, such as other Cryptocurrencies, Cryptocurrency exchanges and micro-lending services.

This is the segment of the Ethereum community that will benefit the most from the new proposed standard. By applying these security measures, they will be able to more effectively meet regulatory requirements, allow for correct internal accounting, mitigate risks to their own funds and add further user protection. Finally, this will help ensure protocol stability, technical viability and scalability.

Integration with the Ethereum network

Maintaining control of attempted outflows during attacks is essential to minimize potential hazards and enhance security.

But how will this be integrated within the Ethereum protocol? As touched upon above, this DeFi protocol adds a so-called circuit breaker mechanism to smart contracts. The circuit breaker mechanism stops token outflows or temporarily pause token outflows, during DeFi hacks.

The integration of said circuit breaker should have very minimal impact when it sees widespread adoption and, upon successful implementation, should protect against catastrophic failures. It also means that a predefined metric can be applied to DeFi protocols, protecting Ethereum community members.

For protocols to be integrated, the core Ethereum team needs to agree and the protocol must receive community support.

What is the ERC-7265 standard?

Defining ERC-7265

Protocol weaknesses and DeFi hacks are said to have costed a total value of $3 billion in 2023. The new standard outlines a way to minimise DeFi exploits, protecting user funds and increasing DeFi security.

Proposed by Diyahir, tcb_00, and real_philogy it seeks to add a fail safe measure, to smart contracts. When a predefined threshold is passed, it’s designed to put a temporary halt on protocol wide token outflows to reduce risks.

When these predefined thresholds are triggered, it will delay settlement and then put temporarily custody on outflows, during a predefined cooldown period.

Technical components and architecture

This new standard could give DeFi entities time to defend against an attacker before an entire contract is drained of its funds.

Although it doesn’t add additional centralisation, it can only be used on upgradable projects, which seems to be the proposed standard’s biggest drawbacks.

ERC 7265 and risk mitigation in DeF

Obviously, the proposed standard seeks to lower the risk profile associated with most protocols. Specific features and user confidence in the standard will likely be seen once the final standard is integrated. Its mechanism of placing funds in temporary custody, its main safety feature, will absolutely contribute to protocol stability, risk reduction and protect against DeFi protocol hackers.

Traditional financial institutions spend inordinate amounts of money to protect their assets both digital and physical. With this new proposal, the ETH network will have another layer protecting the funds held on its blockchain.

This can be further used by smart contract issuers, to offer their clients more peace of mind and maybe even help the network better integrate or communicate with more mainstream financial ecosystems.

ERC 7265’s possible role in boosting DeFi adoption

Overcoming barriers to DeFi adoption

The biggest obstacle to adaptation is first the group of core developers to accept it and the community as a whole to accept and adopt it.

Also, it will need to be tested in real-world scenarios to ensure that the standard is viable, effective and actually does what it says it will.

As mentioned above, another obstacle is that the standard can only be applied to upgradable protocols, so legacy protocols will not be able to integrate.

Use cases and real-world examples

The most obvious use case scenario is creating a network that is no longer appealing to bad actors. Since most hacks have a financial incentive, stopping outflows, will make the network less valuable and in turn less vulnerable to attacks.

Another scenario in which it may be used, if proven effective, is a back stop mechanism to protect assets against unexpected market changes, such as hardware failures or “fat finger” errors.

What are the pros and cons of the ERC-7265 standard?

Advantages of ERC-7265

The safety of the underlying protocol is one of the key features of the new standard. Using the circuit breaker mechanism can protect and give a margin of time for attacks to be defended against or completely shut down.

If the standard proves to be effective enough, it might altogether remove the financial incentive for attacks to happen in the first place.

Disadvantages and challenges of ERC-7265

One of the biggest disadvantages of the standard is also it’s biggest feature – the circuit breaker mechanism. If events are misidentified as threats, it may cause the entire network to lock down.

In a market that is largely fuelled by speculative trading and investing, this would have a huge impact on the value of the network’s underlying tokens.

Although security is the mechanism’s main prerogative, it may be exploited to stop all outflows temporarily and enact a second attack, taking advantage of the locked-down network.

All of these are hypothetical of course and security measures should always be welcomed and embraced by the Cryptocurrency community, as Cryptocurrencies’ biggest appeal, their decentralized nature and anonymity, makes them also the most vulnerable to attacks.

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