Interconnected Protocol Contagion

Interconnected protocol contagion describes how the failure of one DeFi protocol propagates to others due to shared liquidity or dependencies. For example, if a lending protocol relies on the collateral of a decentralized exchange, a crash in the exchange can trigger liquidations across the lending platform.

This web of dependencies creates systemic risk that is difficult to map and manage. Contagion risk is a major hurdle for the stability of the entire ecosystem.

It highlights the need for stress testing protocols against the failure of their primary partners and dependencies.