Summary

repayBadDebtWithReserves() function breaks the core invariant.

Vulnerability Details

One of the core invariant of this protocol is:

exchange rate cannot change from calling functions repayBadDebtWithCash, repayBadDebtWithReserves, or fixUser.

But this invariant doesn't hold true when calling repayBadDebtWithReserves().

The exchange rate is defined as:

In case of calling fixUser() function,

Here, totalBorrows is subtracted by principal amount which will change the exchange rate but badDebt is also increased by the same principal amount which will balance the exchange rate.

But, let's look at repayBadDebtWithReserves() function:

Here, totalReserves is subtracted by some subtractAmount and badDebt is also subtracted by the same amount. For the subtraction of totalReserves and badDebt by some amount, there is no equivalent addition of the subtraction amount. This will decrease the exchange rate and thus breaking the core invariant.

Impact

This issue breaks one of the core invariant of the protocol. Sudden change of exchange rate will hamper the current market with healthy users and it will be unfair to the current holders of the mTokens.

Tools Used

Manual Analysis

Recommendations

Decreasing the totalSupply() by the equivalent amount will balance the exchange rate.