Redemption

The primary risk in redemption is the solvency and honesty of the custodian or issuer holding the underlying assets. If the custodian becomes insolvent, is hacked, or acts fraudulently, redemption rights may be worthless. This is a form of off-chain risk, as the blockchain token's value is contingent on an external promise.

• Examples: A wrapped token's bridge custodian loses funds, a stablecoin issuer's reserves are seized, or a real-world asset (RWA) vault's custodian fails.

The specific on-chain logic governing redemption introduces technical risk. Common mechanisms include:

• Direct 1:1 Swap: A smart contract burns the token and releases the asset (e.g., stablecoins).
• Mint/Burn Pools: Requires sufficient liquidity in a pool (e.g., liquidity provider tokens).
• Request/Claim with Delay: A multi-step process often involving a timelock or cooling period (e.g., 7 days) to allow for fraud proofs and prevent bank runs.

Failure in this smart contract logic can permanently lock funds.

The ability to redeem at the expected value depends on available liquidity. In automated market maker (AMM) based redemptions or for tokens representing illiquid assets, users may suffer significant slippage, receiving less value than the nominal 1:1 claim.

• Example: Redeeming a liquidity provider token during high volatility may result in impermanent loss being realized. For tokenized bonds or private equity, secondary market liquidity may be minimal, forcing reliance on slow, infrequent primary redemptions.

Many redemption processes, especially for collateralized debt positions (CDPs) or overcollateralized stablecoins, depend on price oracles to determine the health of the system and the amount a user can redeem. If an oracle provides stale or manipulated data, redemptions may be executed incorrectly.

• Consequences: Users may be unfairly liquidated, or the protocol may allow redemptions that render it undercollateralized, jeopardizing all users.

In decentralized protocols, redemption rules (fees, timelocks, eligible assets) are often controlled by governance token holders. Malicious or misguided governance actions can alter redemption terms to the detriment of users.

• Risks include: Introducing excessive redemption fees, pausing redemptions indefinitely, changing the underlying collateral basket to riskier assets, or modifying critical smart contract parameters.

Public mempool transactions for redemptions are vulnerable to Maximal Extractable Value (MEV) exploitation. Bots can front-run a user's redemption transaction if it is profitable, such as when redeeming an asset that is trading below its peg.

• Common attack: A sandwich attack where a bot places a trade before and after the redemption, capturing the value as the price corrects, leaving the redeeming user with worse execution.

The destruction of tokens or assets, often a prerequisite for redemption. Burning reduces the total supply and is the cryptographic proof that an asset has been permanently removed from circulation, allowing the release of the underlying collateral.

• Purpose: Creates verifiable scarcity and triggers the release of locked value.
• Example: Redeeming a stablecoin by sending it to a burn address to receive $1 worth of collateral.

The act of removing assets from a smart contract or protocol. While redemption is a specific type of withdrawal that exchanges one asset for another, a general withdrawal simply retrieves deposited assets.

• Key Distinction: All redemptions are withdrawals, but not all withdrawals are redemptions.
• Mechanism: Initiated by a user transaction that calls a contract's withdraw or redeem function.

A smart contract containing paired assets that facilitates trading and redemption. Users can redeem assets directly from these pools, with the redemption price determined by the pool's constant product formula or other automated market maker (AMM) logic.

• Function: Provides an on-chain, non-custodial venue for instant redemptions.
• Example: Swapping a liquidity provider (LP) token back into its constituent tokens (e.g., USDC and DAI).

Assets pledged to back the value of a redeemable token. The quality, quantity, and custody of collateral directly determine redemption safety and efficiency.

• Types: Can be on-chain (cryptoassets), off-chain (real-world assets), or a hybrid.
• Redemption Right: The holder's claim is ultimately a claim on this underlying collateral pool.

The creation of new tokens, which is the inverse operation of redemption. Minting issues new tokens by depositing collateral, while redemption destroys tokens to retrieve collateral.

• Symmetry: These two operations define the mint-redeem lifecycle of synthetic or wrapped assets.
• Economic Role: Minting expands supply; redemption contracts it, helping to maintain peg stability.

The difference between the expected price of a redemption and the actual executed price. In AMM-based redemptions, large transactions can move the pool's price, resulting in unfavorable redemption rates.

• Cause: Low liquidity or large redemption size relative to the pool.
• Mitigation: Setting a maximum slippage tolerance in the transaction.