View source for Merlin DEX Liquidity Pool Drained

{{Imported Case Study 2|source=https://www.quadrigainitiative.com/casestudy/merlindexliquiditypooldrained.php}}[[File:Merlindex.jpg|thumb|Merlin DEX]]Merlin is a decentralized exchange (DEX) based on ZkSync and designed to support both volatile and stable exchanges with minimal fees and fast speed. The platform introduces dynamic directional fees that allow for various fees to be set for each pool and different fees based on the swap direction. Earnings from the protocol will be partially redistributed to stMAGE users and used to maintain a continuous buying pressure on MAGE. However, despite passing its second audit by Certik, Merlin suffered a rug pull during its Liquidity Generation Event, resulting in the loss of $1.8 million. The incident was caused by max approvals granted to the Feeto address upon deployment of the pools, which allowed the individuals in control to drain the pool of all assets and bridge them to ETH. Merlin's post-mortem places the blame on the back-end development team, and the rugged funds were bridged back to Ethereum, swapped for ETH, and transferred to other addresses.

<ref name="unnamed-12515" />

== About Merlin DEX ==
Merlin is a community-focused decentralized exchange (DEX) built on zkSync, a protocol for scalable and secure Ethereum transactions. The platform is designed to offer unique liquidity features, including an innovative yield strategy based on non-fungible staked positions that enhances capital efficiency. Merlin proposed to use two tokens: MAGE, a liquid emission token, and stMAGE, an escrowed governance token that cannot be transferred, to incentivize participants in the ecosystem. Earnings from the protocol would be partially redistributed to stMAGE users in the form of yield and used to maintain a continuous buying pressure on MAGE. stMAGE will be allocated to special contracts known as Plugins, providing additional functionality to the protocol. The platform promised a dynamic automated market maker (AMM) capable of supporting both volatile and stable exchanges with various fees set for each pool and different fees based on the swap direction. Merlin stated a goal of becoming a liquidity beacon in the zkSync ecosystem by surpassing existing DEX offerings and supporting new protocols launching on zkSync<ref name="mage-10739" /><ref name="merlindexmedium-10740" />.

Merlin had just recently passed its second audit by Certik<ref name=":1">[https://twitter.com/TheMerlinDEX/status/1650526832716836866 <nowiki>Merlin DEX - "We are pleased to inform that @CertiK has completed our audit of all of our contracts[. T]he entire report and audit score are available at [CertiK]." - Twitter</nowiki>] (May 9, 2023)</ref> and was in the middle of a 3-day “Liquidity Generation Event” as part of its token (MAGE) launch<ref name="rektnews-10738" />.

== About Merlin DEX Developers ==
The reported backend development team of Merlin DEX consisted of three different developers, which were reportedly all individuals from Serbia.

=== pos-ninja ===
pos-ninja reports himself as a "BlockChain Engineer" and "Certified Blockchain Developer". As of the last time his profile was online, he had made "1,366 contributions in the last year"<ref>[https://web.archive.org/web/20230426175350/https://github.com/pos-ninja pos-ninja Profile - Github Archive April 26th, 2023 11:53:50 AM MDT] (May 16, 2023)</ref>. It appears that at some point prior to May 14th, his Github profile was deleted<ref>[https://web.archive.org/web/20230514061654/https://github.com/pos-ninja pos-ninja Page Not Found - Github Archive May 14th, 2023 12:16:54 AM MDT] (May 16, 2023)</ref>.

=== OneDev0411 ===
OneDev0411 describes himself as a "Full Stack Web Engineer"<ref>https://github.com/OneDev0411 (May 16, 2023)</ref>. He put together an impressive 7,116 contributions through Github in 2022<ref>https://web.archive.org/web/20230516203033/https://github.com/OneDev0411?tab=overview&from=2022-12-01&to=2022-12-31 (May 16, 2023)</ref>.

=== DotNetStar82 ===
DotNetStar82 describes himself as "A Full-stack .Net & Blockchain Developer". He is "ready to start your project anytime" with an extensive list of skills advertised on his Github<ref>https://github.com/dotnetstar82 (May 16, 2023)</ref>.<blockquote>
=== About Me ===

* Like to make a development document with developing content to use that in the future.
* Delivering perfect results at any time.
* Keeping good communication and work on the client's time zone.
* Ability for working with any team and prefer to share much knowledge with many developers.
* Looking for an opportunity to build a long-term relationship with great clients all over the world.
</blockquote>

== The Reality ==
Merlin's audit contained the following warning:<blockquote>"We advise the client to carefully manage the privileged account's private key to avoid any potential risks of being hacked. In general, we strongly recommend centralized privileges or roles in the protocol be improved via a decentralized mechanism or smart-contract-based accounts with enhanced security practices, e.g., multisignature wallets."</blockquote>However, this issue was marked as ‘Resolved’ by Certik, who stated that the Merlin team had promised to use a multisig. This information was only available inside the audit report itself, and many users likely didn't understand the implications of trusting the project.
== What Happened ==
The Merlin DEX drained their liquidity pool where users were depositing as part of the MAGE token sale<ref name="rektnews-10738" />.
{| class="wikitable"
|+Key Event Timeline - Merlin DEX Liquidity Pool Drained
!Date
!Event
!Description
|-
|April 10th, 2023
|Merlin DEX Requests First CertiK Smart Contract Audit
|The Merlin DEX first requests a smart contract audit from CertiK<ref name=":2">[https://web.archive.org/web/20230416154722/https://skynet.certik.com/projects/merlin-dex Merlin DEX Audit Status - CertiK Archive April 16th, 2023 9:47:22 AM MDT] (May 9, 2023)</ref>.
|-
|April 14th, 2023
|First CertiK Smart Contract Audit Revisions Completed
|The Merlin DEX completes the addressing of the feedback from the CertiK audit. The major centralization issue and one control flow issue are resolved, however other issues are merely acknowledged<ref name=":2" />.
|-
|April 17th, 2023
|Merlin DEX Requests Second Smart Contract Audit from CertiK
|Merlin DEX requests a second audit from CertiK<ref name=":3">[https://web.archive.org/web/20230426042417/https://skynet.certik.com/projects/merlin-dex Merlin DEX Audit Status - CertiK Archive April 25th, 2023 10:24:17 PM MDT] (May 9, 2023)</ref>.
|-
|April 24th, 2023 9:47:00 AM MDT
|Completion of Second CertiK Smart Contract Audit
|The Merlin DEX acknowledged the feedback from the second CertiK audit<ref name=":3" />, which found only issues of a Medium and Minor nature. The Merlin DEX platform announces the news on Twitter<ref name=":1" />.
|-
|April 25th, 2023 5:58:00 PM MDT
|Liquidity Pool Draining
|One of the transactions involved in draining the liquidity pool<ref name="zksyncexplorer-10741" /><ref name="zksyncexplorer-10743" />. TBD - figure out what this transaction is:<ref name="zksyncexplorer-10742" />
|-
|April 25th, 2023 7:44:00 PM MDT
|Exploit Warning on Twitter
|An alarm that the liquidity pool had been drained was initially posted on Twitter by Twitter user wasgiventhatday.<ref name="wasgiventhatdaytwitter-10747" />
|-
|April 25th, 2023 10:11:00 PM MDT
|PeckShield Posts On Twitter
|PeckShield posts an alert on Twitter<ref name="peckshieldalerttwitter-10745" />. TBD details.
|-
|April 25th, 2023 11:09:00 PM MDT
|MerlinDEX Acknowledges Incident
|The Merlin DEX acknowledges the exploit on Twitter<ref>[https://twitter.com/TheMerlinDEX/status/1651090982274752513 TheMerlinDEX - "Can everyone revoke connected site access on your wallets/sign permission" - Twitter] (May 8, 2023)</ref>. TBD more details.
|-
|April 26th, 2023 1:21:00 AM MDT
|Beosin Alert on Twitter
|Beosin Alert publishes a warning on Twitter about the exploit<ref name="beosinalerttwitter-10746" />.
|-
|April 26th, 2023 11:47:00 AM MDT
|MerlinDEX Releases Post-Mortem
|The Merlin DEX provides a post-mortem of the exploit on Twitter<ref name="themerlindextwitter-10744" />. They also announce that they have contacted the Serbian authorities<ref name=":0">[https://twitter.com/TheMerlinDEX/status/1651281825816248348 MerlinDEX - We have also notified relevant authorities in Serbia (Region of back-end Team) and work alongside on-chain analysts to monitor the movement of the stolen funds." - Twitter] (May 8, 2023)</ref>. TBD more details.<ref name=":5">[https://twitter.com/TheMerlinDEX/status/1651281831436615693 TheMerlinDEX - "We are deeply saddened by the actions of the technical team, whom we put a high degree of trust in. Merlin will continue to support our community and resolve the issue." - Twitter] (May 16, 2023)</ref>
|-
|April 27th, 2023 1:13:00 PM MDT
|Rekt Publishes Article
|The situation is published on Rekt<ref>[https://twitter.com/RektHQ/status/1651665786107224065 RektHQ - "$1.8M gone in a puff of smoke as @TheMerlinDEX pulled a classic DeFi magic trick. This is the first rekt we've covered on zksync, but far from the first to be audited by Certik..." - Twitter] (May 8, 2023)</ref>. TBD more description<ref name="rektnews-10738" />.
|-
|May 3rd, 2023 1:26:24 AM MDT
|CertiK Updates Security Score
|CertiK updated the security score of the Merlin DEX project to a status of "Exit Scam"<ref>[https://web.archive.org/web/20230503072624/https://skynet.certik.com/projects/merlin-dex Merlin DEX Audit Status - CertiK Archive May 3rd, 2023 1:26:24 AM MDT] (May 9, 2023)</ref>. TBD - This happened prior and it would be good to get the real date.
|}

== Technical Details ==
This is not an advanced type of attack. The liquidity pool where users were depositing funds as part of the MAGE token sale was directly drained<ref name="rektnews-10738" />.

Normally, a liquidity pool maintains two assets which are traded against one another. There were two lines of code added in the initialize function of the smart contract which granted approval for the "feeTo" address to transfer an unlimited amount of both tokens from the liquidity pool<ref name=":4">[https://twitter.com/zkaliburDEX/status/1651087592052359169 zkaliburDEX - "These two lines of code in the initialize function are essentially granting approval for the feeTo address to transfer an unlimited (type(uint256).max) amount of token0 and token1 from the contract's address." - Twitter] (May 9, 2023)</ref>.

<code>function initialize (address _token0, address _token1) external {</code>

<code>require(msg.sender == factory && !initialized, 'MerlinSwapPair: FORBIDDEN');</code>

<code>// sufficient check</code>

<code>token0 = _token0;</code>

<code>token1 = _token1;</code>

<code>'''IERC20(token0).approve(IMerlinSwapFactory(factory).feeTo(), type(uint256).max);'''</code>

<code>'''IERC20(token1).approve(IMerlinSwapFactory(factory).feeTo(), type(uint256).max);'''</code>

<code>...</code>

The new code granted a maximum unlimited approval for the owner of the "feeTo" address to pull as much money as they wanted from the liquidity pool<ref name=":4" />.

While the original CertiK audit did originally reject the first version of the smart contract due to a centralization issue, this was resolved by the implementation of a multi-signature wallet. However, there was no way to verify that the multi-signature address were, in fact, owned by separate individuals acting autonomously.

The individual(s) in control of the Feeto address could then drain the pool of all assets, which were then bridged to ETH<ref name="rektnews-10738" />.

"Merlin’s own post-mortem places the blame squarely on the back-end development team. The thread includes links to developers’ github profiles and states that Serbian authorities have been contacted."

<blockquote>Furthermore, the back-end team who also have access to our web-host had unknowingly manipulated our code to achieve their goal.

We had submitted all intended contracts to be used on our platform to Certik who carried out a full audit. However there has been a clear oversight on the overarching power the _owner had of the pools.

They chose to carry out several on-chain transactions to drain all of Merlin's pools, public sale and manipulate our front-end contracts. This was done by implementing a function that allows a Call action to all Merlin Pairs alongside hidden Front-End Contracts.</blockquote>

== Total Amount Lost ==
Rekt reports the amount drained from the liquidity pool as $1.8m<ref name="rektnews-10738" />.

The total amount lost has been estimated at $1,800,000 USD.

== Immediate Reactions ==
The initial alarm was raised by community member wasgiventhatday, before blockchain research firm Peckshield spread the message. Merlin then acknowledged the incident the following day, advising users to revoke permissions as a precaution<ref name="rektnews-10738" />.

=== Initial Warning On Twitter ===
Twitter user wasgiventhatday originally posted on Twitter to warn about the exploit<ref name="wasgiventhatdaytwitter-10747" />.<blockquote>@circle 0xb72200739d557ce12b41876772e1e434af896644 has rugged @TheMerlinDEX of $147k . Can you please freeze his USDC on main net?</blockquote>

== Ultimate Outcome ==
The Merlin DEX released a post-mortem a couple of days after the incident.

=== Merlin DEX Releases Post-Mortem ===
The Merlin DEX provided a post mortem of the exploit on the following day<ref name="themerlindextwitter-10744" />.<blockquote>it is with deepest regret that we have to notify you of a major fault in the structural integrity and controls of the Merlin Platform. 

In the early hours of this morning the several members of the Back-End Team drained all of our Contracts.

Back-End Technical Team Committers:

<nowiki>https://github.com/pos-ninja</nowiki>

<nowiki>https://github.com/dotnetstar82</nowiki>

<nowiki>https://github.com/OneDev0411</nowiki>

Notable Prior Projects:

@DynoChainNet

@discoverilla (Technical Leads Project)

@InterFiNetwork (KYC + Audit)

They chose to carry out several on-chain transactions to drain all of Merlin's pools, public sale and manipulate our front-end contracts. This was done by implementing a function that allows a Call action to all Merlin Pairs alongside hidden Front-End Contracts.

We had submitted all intended contracts to be used on our platform to Certik who carried out a full audit. However there has been a clear oversight on the overarching power the _owner had of the pools.

Furthermore, the back-end team who also have access to our web-host had unknowingly manipulated our code to achieve their goal.

Our unwavering priority is to return all funds to effected parties and participants on the Merlin platform at the earliest opportunity. To that end, we are working alongside @Certik (Team DOXX by both Prospero & Alatar Recovery Plan) to reimburse all effected users.

We have also notified relevant authorities in Serbia (Region of back-end Team) and work alongside on-chain analysts to monitor the movement of the stolen funds.

These have been tracked to two wallets which can be found below :  <nowiki>https://debank.com/profile/0xa7d481944730a88b862eb57248cb1b2c8aa358ad</nowiki>

The wallet _owner/deployer of all effected contracts on ZkSync Mainnet at source are :   

<nowiki>https://explorer.zksync.io/address/0xc0D6987d10430292A3ca994dd7A31E461eb28182</nowiki>  

<nowiki>https://explorer.zksync.io/address/0xc7fD785f81Fe6bBb499009746a2BCbbdd895f5b0</nowiki>

We are deeply saddened by the actions of the technical team, whom we put a high degree of trust in. Merlin will continue to support our community and resolve the issue.</blockquote>

=== Attempts At Recovery ===


"The rugged funds were bridged back to Ethereum, swapped for ETH and transferred to other addresses."

"Merlin’s own post-mortem places the blame squarely on the back-end development team. The thread includes links to developers’ github profiles and states that Serbian authorities have been contacted."<ref name=":0" />

== Total Amount Recovered ==
It doesn't appear that any funds were recovered. It was reported that the funds were bridged back to Ethereum, swapped for ETH, and transferred to other addresses<ref name="rektnews-10738" />.

== Ongoing Developments ==
Merlin’s post-mortem places the blame on the back-end development team. The thread includes links to developers’ Github profiles and states that Serbian authorities have been contacted. It's reported that the withdrawn funds were bridged back to Ethereum, swapped for ETH and transferred to other addresses<ref name="rektnews-10738" />.

Merlin released a statement describing how they plan to move forward<ref name=":5" />.<blockquote>We are deeply saddened by the actions of the technical team, whom we put a high degree of trust in. Merlin will continue to support our community and resolve the issue.</blockquote>

== Individual Prevention Policies ==
{{Prevention:Individual:Avoid Using Smart Contracts}}

{{Prevention:Individuals:End}}

== Platform Prevention Policies ==
{{Prevention:Platforms:Regular Audit Procedures}}

{{Prevention:Platforms:End}}

== Regulatory Prevention Policies ==
{{Prevention:Regulators:Platform Security Assessments}}

{{Prevention:Regulators:End}}

== References ==
<references>
<ref name="rektnews-10738">[https://rekt.news/merlin-dex-rekt/ Rekt - Merlin DEX - REKT] (May 3, 2023)</ref>
<ref name="mage-10739">[http://mage.exchange/ Mage.Exchange | MerlinDEX] (May 3, 2023)</ref>
<ref name="merlindexmedium-10740">[https://merlindex.medium.com/merlin-a-zksync-dex-liquidity-lodger-fa71657c081d Merlin A Zksync Dex Liquidity Lodger - Merlin DEX Medium] (May 3, 2023)</ref>
<ref name="zksyncexplorer-10741">[https://explorer.zksync.io/address/0x2744d62a1e9ab975f4d77fe52e16206464ea79b7 Attacker's Address - zkSync Era Block Explorer] (May 3, 2023)</ref>
<ref name="zksyncexplorer-10742">[https://explorer.zksync.io/tx/0x1707b898638cd5a897ab793d0fadc3c608e4e78ff184fbfdb4f80ec874692355 Transaction - zkSync Era Block Explorer] (May 3, 2023)</ref>
<ref name="zksyncexplorer-10743">[https://explorer.zksync.io/tx/0x60e652f7d956a76982aeb8caa2f6e9bf73b854ffc3d7f539d4942c326f97eef4 Transaction Draining USDC Liquidity - zkSync Era Block Explorer] (May 3, 2023)</ref>
<ref name="themerlindextwitter-10744">[https://twitter.com/TheMerlinDEX/status/1651281814395187200 TheMerlinDEX - "it is with deepest regret that we have to notify you of a major fault in the structural integrity and controls of the Merlin Platform." - Twitter] (May 3, 2023)</ref>
<ref name="peckshieldalerttwitter-10745">[https://twitter.com/PeckShieldAlert/status/1651076481240690689 PeckShieldAlert - "#PeckShieldAlert Our community contributor has reported that Merlin #DEX on #zksync was exploited." - Twitter] (May 3, 2023)</ref>
<ref name="beosinalerttwitter-10746">[https://twitter.com/BeosinAlert/status/1651124285409460224 BeosinAlert - "@TheMerlinDEX Merlin Dex on ZkSync rugged with $1.8M." - Twitter] (May 3, 2023)</ref>
<ref name="wasgiventhatdaytwitter-10747">[https://twitter.com/wasgiventhatday/status/1651039576860000257 wasgiventhatday - "@circle 0xb72200739d557ce12b41876772e1e434af896644 has rugged @TheMerlinDEX of $147k . Can you please freeze his USDC on main net?" - Twitter] (May 3, 2023)</ref>
<ref name="unnamed-12515">[https://medium.com/@nelsonblue41/introduction-to-merlin-d489a40cf4d6 https://medium.com/@nelsonblue41/introduction-to-merlin-d489a40cf4d6] (Nov 30, 2023)</ref>
</references>