Euler Finance: an Overview of DeFi protocol security and capabilities

Euler Finance is a DeFi protocol built on the Ethereum blockchain. It operates like a decentralized bank where you can lend your digital assets to others and earn interest, or take out loans backed by your own cryptocurrency as collateral.

You will learn about all the advantages and risks of this protocol. We will also look at what yields it can offer and what strategies are available.

Euler Finance Overview

The essence of the protocol is that you can earn on your crypto assets using the protocol's ready-made strategies, rather than doing everything yourself. Many actions that would otherwise require step-by-step execution across multiple protocols are already algorithmized. You can activate a chosen strategy in just a few steps. But there are always nuances, which we will discuss below.

Other protocol capabilities include leverage and earning income in the form of interest from participating in pools.

The first thing we look at is the TVL metric. It's the "piggy bank" showing the protocol's popularity. Check the current amount of funds deposited (TVL) into the protocol here.

However, a high TVL does not guarantee safety. Reliability comes from understanding how the protocol works and the risks involved.

How does the Euler protocol work?

The protocol includes so-called vaults. These are like safes where people deposit funds in exchange for "shares" of the vault, and the vault allocates them across strategies to generate profit.

The architecture of Euler v2 is modular. Anyone can create their own lending market without seeking permission from the protocol team or DAO. And these vaults interconnect through the Ethereum Vault Connector (EVC). Thanks to EVC, you can place collateral in one vault and take a loan from another, combining them into a single strategy.

Simply put, Euler resembles a modular construction kit for credit markets, where flexibility is combined with risk isolation.

The diagram demonstrates modularity: thanks to EVC, different vaults can interact with each other.

Another interesting concept of the Euler Protocol is its DEX exchange. The structure of the protocol's vaults allows for the creation of not only lending pairs but also trading pairs. When capital on Euler's lending market is idle, it can be lent out to the Euler DEX, which uses these pairs to perform swaps.

Naturally, Euler DEX liquidity providers can make their capital more productive by directing it back to the lending market. This increases user yields.

Note another feature: liquidity providers can use their LP token with leverage to execute larger swaps. Typically, leverage is taken only for the duration of the swap and is immediately returned - this concept is called "just-in-time liquidity". This is shown in the diagram below.

The left column (Lending) consolidates collateral assets, while the right column (DEX) converts them into trading pairs for implementing "just-in-time liquidity" strategies. Green arrows indicate direct supply of funds, and yellow arrows visualize borrowing against collateral to instantly fill pools in response to a trade request.

We've described the technical workings of the protocol. But if you're new to crypto lending, remember 3 important concepts:

1. Health factor - a safety metric for your loan. If it's above 1 - all good. If it drops to 1 or below - your collateral will be seized (liquidated).
2. Soft liquidation - Euler's feature: the penalty starts at 0% and increases dynamically, up to a maximum of 20%. This is more favorable than in other protocols.
3. Multiply strategies - a way to reinvest collateral repeatedly in a single transaction to greatly increase yield. For experienced users.

Now let's examine the protocol from a security perspective.

How secure is the protocol?

Euler Finance's security has evolved from a $200 million hack in 2023 to one of the most thoroughly audited DeFi protocols with V2. User funds that were stolen were returned, and the team developed Euler V2, separating the system into individual components.

The modular structure of the protocol (EVK + EVC) isolates risks. Problems in one vault do not affect the entire protocol.

Ultimately, to launch version v2, the project conducted an audit competition on the Cantina platform with a prize pool of $1.25 million, implemented formal verification through Certora, and underwent 45 external checks by 13 audit firms. Audits can be found here.

The protocol appears secure from an audit standpoint, yet fundamental DeFi risks always remain.

What are the fundamental risks of DeFi protocols?

It's important to understand that despite high annual percentage yields, DeFi is not massively popular due to several fundamental risks.

Before using the protocol, you need to be aware of these risks:

• Liquidation risk. When Health Score = 1, the position becomes eligible for liquidation. Euler implements soft liquidation. You will be charged exactly as much as needed to incentivize the market to close your position. Often this is 1–2% instead of a fixed 20%.
• Interest rate risk. This is the utilization rate of borrowed funds from the total pool: the higher this metric, the less free funds are available in the system and the more expensive your loan becomes. And this can quickly turn your profit into loss.
• Oracle risk - dependence on Chainlink, Pyth, Redstone networks. Data errors, delays, or price manipulations lead to incorrect liquidations.
• Liquidity risk - when a vault is fully utilized, lenders may temporarily be unable to withdraw funds.

Now let's look at the modularity of Euler V2 and potential risks.

• Liquidity fragmentation - isolated vaults and multichain deployment, as opposed to a monolithic structure (like Aave), increase rate volatility.
• Complexity - sub-accounts, Borrow Factors, LTV Ramping create a high entry barrier for beginners. Configuration errors in Multiply strategies can lead to loss of capital.
• Slippage - automatic swaps in Multiply strategies result in losses due to price differences.

Having understood all the risks, let's now look at the protocol's sections and what they offer. First, let's look at the EARN section.

Earn Section

In the Earn section, you deposit assets, such as USDC, Ether, or USDT, into a pool, and the protocol accrues a percentage yield for providing them.

An important feature of Euler is compatibility with multiple EVM networks, including Ethereum, Base, Plasma, Arbitrum, and other networks.

The base APY rates for providing liquidity may not be impressive on their own, but the true value is revealed in the strategies, which we will discuss next.

The next feature is Lend.

Lend Section

This is a lending protocol where you can deposit assets and borrow them. It implements the familiar features of a lending platform (similar to Aave): you can supply assets, and you can borrow against collateral.

Adjacent is the borrow tab, which allows you to take loans against various assets as collateral, including staked token versions, across different networks. The mechanics become especially interesting if you use PT (Principal Token) from the Pendle ecosystem as collateral.

This allows you to borrow funds and increase (leverage) your exposure to the underlying yield-bearing asset.

However, the most promising feature, in our view, is concentrated in the Strategies tab.

How do Euler strategies work?

Strategies in Euler act as an automatic multiplier or loop. The protocol itself performs lending and borrowing operations, repeating the cycle several times to amplify your yield.

For example, a strategy with the PT-sUSDai token can show ROE of up to 67%. High ROE is often found in strategies from the Pendle Finance protocol with a fixed maturity date.

As the expiration date approaches, the return on equity (ROE) can increase significantly (due to time constraints), becoming much higher than typical market values. However, it's important to understand the risks. While the yield of the PT token is fixed, the borrowing cost (Borrow APY) is volatile. If the borrowing cost exceeds the yield on the collateral, the position can become unprofitable (negative ROE).

Consider another example on the Plasma network: the PT-SUSDAI token shows a potential ROE of around 25.75%.

The principle is this: the protocol allows you to use the PT token itself as collateral to borrow USDT.

How to understand the terms?

• Your profit comes from the difference between the fixed yield of the PT token and the variable interest rate on the USDT loan.
• If the yield on PT is higher (e.g., 10.05% vs. 8.1% on the loan), this positive difference (delta) is amplified many times over, increasing the final ROE.

However, it's important to consider the risks and monitor the metrics closely.

What are the risks and position management?

The fixed yield rate of the PT token is reliable, but the borrowing APY on the asset you borrow (e.g., USDT) is variable and can fluctuate.

Consider a real example of an open position of ours, where a negative net ROE is temporarily observed. This happens because the borrowing rate on USDT briefly rose above the collateral yield rate.

Such spikes usually last a few hours, after which the rate returns to normal. This should not be a cause for concern as long as the Net Asset Value remains positive. This is shown in the top right corner.

The signal to close a position and look for a new strategy should be a negative ROE persisting for several consecutive days.

The main takeaway is that although Euler automates the cycles of yield amplification, the responsibility for monitoring interest rates falls on you as the liquidity provider, so you can react in time to changes and maintain profitability.

Detailed risk analysis and curators

Regarding security, it's important to understand the curator system. Who are they? Curators (Governors or Risk Curators) are organizations or individuals who create vaults (liquidity pools) and manage protocol parameters. They are responsible for risk and receive a share of the vault fees.

What do vault curators do?

• Set LTV (maximum loan-to-value ratio), borrowing factors, and liquidation thresholds.
• Choose price oracles (Chainlink, Pyth, etc.).
• Determine which assets are accepted as collateral.
• In Euler Earn, allocate capital between yield strategies.

The list of curators and their TVL is displayed in the filter.

It is important to understand that curators cannot withdraw user funds. However, for those who wish to avoid their influence, there are ungoverned vaults with fixed parameters.

Thus, users depositing funds into governed vaults are trusting the curator's expertise. The main risk is that a curator might make poor decisions: set too high an LTV for a volatile asset or choose an unreliable oracle. Any of these could make the vault unsafe and vulnerable to liquidations.

Recall that LTV (Loan-to-Value) in DeFi protocols determines the maximum portion of the collateral value a user can borrow. For example, with an LTV of 75%, depositing $100 worth of ETH as collateral allows a loan of $75 in stablecoins.

Step-by-step guide to Euler Finance

Having understood how the protocol works and how to manage positions, let's move to practice. Go to the official website. Avoid phishing links. Be attentive and double-check - this is always good practice for a crypto investor.

1. Select the Strategies tab. Ready-made strategies will be presented there.
2. Choose a stablecoin strategy with leverage, for example USDC 2X. Remember the liquidation risks.
3. Deposit assets and activate the strategy. MetaMask, Rabby, or any other EVM wallet will work.
4. Monitor the yield. Interest is automatically accrued in the chosen coin.
5. Exit partially if desired and lock in profits. This is an important principle. You don't have to reinvest all profits back. You can grow realized PNL and withdraw it to your wallet for further investments or expenses.

Start with small amounts to understand how the protocol works, and gradually increase your position. Don't be too greedy - that's a red flag in crypto!

We recommend keeping your account tab open in your browser throughout the day to track overall ROI. If it turns negative, take the position under control.

How does the Multiplier work?

An advanced option is the Position Amplification function (Multiplier). Multiply in Euler Finance automates leverage in a single transaction: it sequentially performs borrowing, swapping via DEX, and reinvesting up to a specified multiplier (selected with a slider).

In other words, the Multiplier is the leverage factor, determining how many times the total position size exceeds the initial collateral. For example, with a 10x multiplier, depositing 100 USDT creates a position of 1000 USDT, where 900 USDT are borrowed funds. Its maximum value is set individually for each trading pair in the Borrow and Strategies tabs.

The Multiply function automates capital looping in a single transaction, but high leverage increases the risk of liquidation when the Health Score ≤ 1, increases slippage (Leveraged price impact), and interest burden (Borrow APY). At the same time, you can dynamically change the multiplier of an open position by borrowing more or repaying debt.

Why is the EUL token needed?

EUL is the native governance token of the Euler Finance ecosystem, ensuring the protocol's sustainability. The EUL unlock schedule is designed for gradual and predictable token release to minimize sharp price fluctuations.

Here's what the EUL token does:

• Fee Flow - the protocol sells accumulated fees (in hundreds of currencies) through Dutch auctions at a discount. Payment is only possible in EUL, which creates constant demand for the token.
• rEUL - liquidity rewards with a 6-month vesting period. They can be claimed immediately with a penalty or after the unlock period.
• Governance - holders vote in the Euler DAO on risk parameters, budgets, and protocol upgrades. This is used by large players.
• Integrations – the token is available in programs like Binance Simple Earn.

Thus, the value of EUL is directly tied to the protocol's yield through the auction buyback model. This distinguishes it from many other "empty" governance tokens in DeFi.

Conclusion

The modularity of Euler V2 allows DeFi to scale to new asset types (RWA, Liquid Staking) while maintaining a high level of security through the technical isolation of each module.

Euler's cross-network compatibility and automated looping of yield amplification make the protocol interesting and similar to protocols like Camino Multiply or Jupiter Land Multiply on Solana, or Contango Finance on Ethereum.

The protocol automates looping, which manually would require multiple transactions.

Disadvantages: liquidity is fragmented across all monolithic instances built on top of the Euler Protocol, and, further exacerbating the problem, liquidity is also distributed across all blockchains on which the protocol is deployed.

Additionally, the Euler Protocol will find it difficult to carve out a unique market position, as all these monolithic structures resemble Aave, and the Aave Protocol has significantly higher liquidity. This creates a much stronger capital attraction effect than Euler Protocol has.

Comparison of Euler with Aave, Compound

Characteristic	Monolithic protocols (Aave, Compound, Euler V1)	Modular / Isolated systems (Euler V2, Morpho, Silo)
Architecture	All assets are pooled into one giant pool.	Consist of many independent vaults that can be connected to each other.
Risk management	Systemic risk. The protocol is only as strong as its weakest collateral. A problem with one asset can bring down the entire system.	Isolated risk. Issues or a hack of one vault do not spread to others, protecting the funds of other users.
Asset listing	Restricted. The DAO acts as a "gatekeeper", deciding by vote which assets are eligible for listing.	Permissionless. Any user can create a market for any token without protocol approval.
Capital efficiency	Maximum. Any asset in the pool can serve as collateral for any other asset.	Depends on configuration. Liquidity is fragmented across markets, but Euler V2 allows vaults to be combined into "clusters" to improve efficiency.
Configuration flexibility	Parameters (LTV, oracles, rates) are fixed for the entire protocol and can only be changed via DAO.	Each vault has unique LTV settings, rate models, and oracle choices (Chainlink, Pyth, etc.).
Governance model	Global paternalism. Users rely on the DAO's risk management and take a passive role.	Free market. Users choose vaults or curators (Governors) whose risk management strategies they trust.

   

Technical risks include oracle failures and smart contract vulnerabilities, and even a correlated pair like USDT/USDC can lead to liquidation due to changes in interest rates or liquidity, so it's recommended to start with small amounts and constantly monitor LTV.

Advantages of the Euler Protocol include the most flexible protocol structure for developers and market makers. For example, if someone wanted to recreate a structure similar to Aave, the easiest way to do it would be on the Euler Protocol.

Additionally, the increased capital efficiency between the lending market and DEX should provide better rates for users.

Study the available strategies, conduct your own research, and always thoroughly understand the mechanics of both the protocol itself and the assets you invest in. Don't miss our guide to DefiLlama for analyzing and finding DeFi protocols.

Maksim Anisimov, specially for bytwork.com.

 

Disclaimer: this is not financial advice; always do your own research.