bad debt is not socialized

[c4-bot-6]

Lines of code

https://github.com/code-423n4/2023-12-initcapital/blob/main/contracts/core/InitCore.sol#L288

Vulnerability details

Proof of Concept

In case if borrower's position is unhealthy, then he can be liquidated. Liquidator can provide amount of shares in _poolToRepay that he will cover and expects to get back _poolOut shares. It is possible that position created a bad debt. This means that amount that position has borrowed is bigger than supplied collateral.

In this case only part of debt of the positon will be repaid to lenders by liquidator. Let's check what that means for the pool.

When burn is called, then _toAmt is called to calculate amount that user can receive for his shares. It uses cash + totalDebt and totalSupply to calculate it. totalDebt is all borrowed amount that is not repaid yet. So contract expects that all borrowed amount will be repaid eventually.

So in case if bad debt occurs it means that part of borrowed amount will not be received back by LendingPool contract, however contract still calculates assets using outdated data.

As result this bad debt will create contract insolvency, which means that contract will not have enough balance to pay last burners.

Impact

Bad debt is not distributed among all lenders

Tools Used

Recommended Mitigation Steps

You should track when position is closed with bad debt and then notify LendingPool contract that borrower will not be able to return part of funds. This should decrease totalDebt amount, which will decrease share price and thus distribute that debt among all lenders.

Assessed type

Error

[c4-judge]

hansfriese marked the issue as duplicate of #9

[fez-init]

@hansfriese This issue is different from #9 .

[hansfriese]

@fez-init Would you explain in detail what the differences are? From my understanding, both issues are saying totalDebt should be updated properly by distributing a debt among all lenders when a position is closed with a bad debt.

[fez-init]

@hansfriese This issue talks about a recommendation where bad debt should be socialized to all lenders.

9 talks about the case of tx revert when bad debt occurs. When bad debt occurs, what will likely happen is:

1) a liquidator can come in and repay partial debt and take ALL the collaterals (since there are liquidation premiums). So we are left with 0 collateral and >0 debt. 2) The idea is that we would like to be able to liquidate this debt as well. However, in the liquidate function, it will try to removeCollateral to the liquidator, and there's a check that requires share > 0 so the secondary liquidation will always undesirably revert.

[c4-sponsor]

fez-init marked the issue as disagree with severity

[fez-init]

This issue should be marked as part of low or QA since it is more of a recommendation to the design choice.

[c4-sponsor]

fez-init (sponsor) acknowledged

[hansfriese]

Downgrade to QA as it doesn't show the main impact.

[c4-judge]

hansfriese marked the issue as not a duplicate

[c4-judge]

hansfriese changed the severity to QA (Quality Assurance)

[c4-judge]

hansfriese marked the issue as grade-c

[rvierdiiev]

hello @hansfriese I understand that #9 moves 1 step further and discovers that liquidation is not possible when position was liquidated and bad debt have occured. However i do not agree that this report doesn't show the main impact. Because for me the main impact is not disability to repay bad debt loan by anyone else, but the main impact is system insolvency.

While i agree that protocol is able(and likely will) to repay some bad debt, i didn't see any solution from protocol side to do that. I mean that in case of big amount of bad debt, it can be not enough just to use protocol's fee as protocol fee is not guaranteed to stay in the contracts and can be withdrawn at any time.

Insolvency was always bigger than qa, that's why i believe this is medium severity issue.

[hansfriese]

@rvierdiyev I totally understand your point.

1. I agree the main impact is the system insolvency and it's worth keeping this report as Medium because there is no specific solution to resolve.

2. 9 shows a more severe impact by clarifying that it's impossible to liquidate positions with 0 collaterals.

   For the above reasons, I think it's appropriate to mark this one as a dup of #9 with 50% partial credit.

[c4-judge]

hansfriese removed the grade

[c4-judge]

This previously downgraded issue has been upgraded by hansfriese

[c4-judge]

This previously downgraded issue has been upgraded by hansfriese

[c4-judge]

hansfriese marked the issue as duplicate of #9

[c4-judge]

hansfriese marked the issue as partial-50

[c4-judge]

hansfriese marked the issue as satisfactory

[c4-judge]

hansfriese marked the issue as partial-50