Naked Redeemer is a critical security vulnerability in asynchronous settlement systems where a user's vault shares are burned or locked upon requesting redemption, but the off-chain settlement process fails to deliver the underlying assets—leaving the user with neither their shares (proof of ownership) nor the expected redemption proceeds. The term captures the "exposed" state of users who have surrendered their on-chain position but not yet received off-chain compensation.

This risk is unique to RWA vaults handling exogenous liquidity. In synchronous ERC-4626 vaults, redemption is atomic: shares burn and assets transfer in the same transaction. If anything fails, the entire operation reverts, and the user retains their shares. Asynchronous settlement breaks this atomicity, creating a window where users are vulnerable to settlement failure.

Attack Vectors and Failure Modes

Custodian Insolvency: The custodian holding underlying assets (Treasury bills, bonds, real estate titles) becomes insolvent between redemption request and settlement. The user's shares are already burned, but the custodian cannot deliver the proceeds. The on-chain record shows the user redeemed; the off-chain reality shows assets vanished.

Liquidity Crisis: The underlying asset becomes illiquid. For tokenized real estate, the property cannot be sold at acceptable prices. For bonds, market dislocation prevents liquidation. The user's redemption request is valid, their shares burned, but no buyer exists for the underlying asset. They're "naked"—exposed without recourse.

Operational Failure: Wire transfers fail, bank accounts are frozen, compliance issues arise, or custodian systems malfunction. The off-chain steps required to complete settlement don't execute. The user loses their shares (surrendered on-chain) but receives nothing (off-chain failure).

Regulatory Seizure: Underlying assets are frozen by regulatory action. Sanctions, investigations, or court orders prevent asset transfer. The vault cannot complete redemptions even though it's technically solvent. Users with pending redemptions lose their position.

Oracle Manipulation: Malicious or compromised oracles confirm settlements that never occurred. Users' shares burn based on false confirmations. When the fraud is discovered, the assets are gone, and so are the shares.

Smart Contract Exploit: The vault contract is exploited between redemption request and settlement. Attackers drain assets while legitimate redemption requests are pending. The protocol becomes insolvent, but users' shares are already burned or locked.

Why Shares Are Burned/Locked

Asynchronous redemption typically burns or locks shares immediately upon request for valid reasons:

Prevent Double-Spending: If shares remained active during pending redemption, users could: transfer shares while awaiting redemption (double-claiming), use shares as collateral elsewhere (leveraged exposure), or sell shares on secondary markets (defrauding buyers).

Accurate Supply Accounting: Total share supply should reflect actual claims on assets. If redemption-pending shares remain in circulation, the share supply overstates claims on the asset base, creating accounting inconsistencies and potential manipulation.

Regulatory Compliance: Securities regulations often require clear ownership records. A share that's "in redemption" creates ambiguity about ownership status. Burning or locking provides clear state: either you hold shares, or you have a redemption claim—not both.

Prevent Redemption Arbitrage: If shares remained transferable during redemption, sophisticated actors could: redeem shares when NAV is favorable, cancel if NAV moves against them, or sell shares if redemption seems likely to fail. This creates asymmetric risk exposure.

Mitigation Strategies

Cancellation Mechanisms: ERC-7887 proposes standardized cancellation for ERC-7540 vaults. Users can cancel pending redemptions before settlement, reclaiming their shares:

1function cancelRedeemRequest(uint256 requestId, address controller) external {
2    require(msg.sender == controller || msg.sender == owner, "Unauthorized");
3    require(requestStatus[requestId] == Status.Pending, "Not cancellable");
4    
5    // Return locked shares to owner
6    shares.transfer(owner, pendingShares[requestId]);
7    requestStatus[requestId] = Status.Cancelled;
8}

This provides an escape valve: if settlement is taking too long or seems likely to fail, users can recover their position.

Timeout Protections: Automatic cancellation if settlement doesn't complete within defined windows:

1uint256 public constant MAX_SETTLEMENT_TIME = 7 days;
2
3function claimOrCancel(uint256 requestId) external {
4    if (requestStatus[requestId] == Status.Claimable) {
5        // Normal claim flow
6        claimRedeem(requestId);
7    } else if (block.timestamp > requestTimestamp[requestId] + MAX_SETTLEMENT_TIME) {
8        // Auto-cancel after timeout
9        cancelRedeemRequest(requestId);
10    } else {
11        revert("Settlement pending");
12    }
13}

Users aren't indefinitely exposed—if the vault can't settle, they eventually recover their shares.

Insurance/Backstop Funds: Protocol-level insurance covering settlement failures:

1function emergencySettle(uint256 requestId) external {
2    require(requestStatus[requestId] == Status.Failed, "Not failed");
3    
4    // Pay from insurance fund instead of failed settlement
5    uint256 insuredValue = calculateInsuredValue(requestId);
6    insuranceFund.transfer(owner[requestId], insuredValue);
7    requestStatus[requestId] = Status.InsurancePaid;
8}

This doesn't prevent the naked redeemer situation but provides financial compensation when it occurs.

Partial Burning: Instead of burning all shares immediately, burn proportionally as settlement progresses:

1function requestRedeem(uint256 shares) external {
2    // Lock shares, don't burn
3    shares.transferFrom(msg.sender, address(this), shares);
4    pendingRedeems[msg.sender] = shares;
5}
6
7function confirmPartialSettlement(uint256 requestId, uint256 settledPercent) external onlyOperator {
8    uint256 sharesToBurn = pendingShares[requestId] * settledPercent / 100;
9    uint256 assetsToRelease = calculateAssets(sharesToBurn);
10    
11    // Burn only what's settled
12    shares.burn(sharesToBurn);
13    assets.transfer(owner[requestId], assetsToRelease);
14    
15    pendingShares[requestId] -= sharesToBurn;
16}

Users remain partially protected until settlement actually completes.

Escrow Structures: Hold both shares and preliminary assets in escrow during settlement:

1function requestRedeem(uint256 shares) external {
2    shares.transferFrom(msg.sender, escrow, shares);
3    // Reserve assets from buffer/liquid portion
4    assets.transferFrom(vault, escrow, estimatedValue);
5    
6    pendingRedeems[msg.sender] = RedeemRequest({
7        shares: shares,
8        reservedAssets: estimatedValue,
9        status: Pending
10    });
11}

If settlement fails, the escrow returns shares; if it succeeds, escrow releases assets and burns shares.

Audit Checklist for Naked Redeemer Risk

1. Share State During Redemption: Are shares burned, locked, or transferable during pending redemption?
2. Cancellation Rights: Can users cancel pending redemptions? Under what conditions?
3. Timeout Mechanisms: What happens if settlement never completes? Is there automatic resolution?
4. Failure Handling: How does the protocol handle settlement failures? Who bears the loss?
5. Insurance Coverage: Is there backstop funding for settlement failures?
6. Operator Powers: Can operators force-fail settlements? What prevents abuse?
7. Partial Settlement: How are partial completions handled? Can users recover unsettled portions?
8. Communication: Are users informed of their exposure during pending redemption?

Risk Assessment Framework

When evaluating naked redeemer risk, consider:

Probability: How likely is settlement failure? Factors include: custodian reliability, asset liquidity, operational track record, and regulatory stability.

Exposure Window: How long are users naked? Longer settlement times increase exposure. T+2 securities have shorter windows than illiquid real estate.

Recovery Mechanisms: If failure occurs, what recourse exists? Strong cancellation mechanisms reduce effective risk even if failure probability is higher.

Loss Magnitude: What's the maximum loss? Full share value, or are there caps/insurance?

User Awareness: Do users understand the risk when initiating redemption? Informed users can make risk-adjusted decisions.

Real-World Considerations

The naked redeemer problem reflects fundamental challenges in bridging blockchain finality with traditional finance settlement:

Trust Tradeoff: Either users trust the protocol to complete settlement (accepting naked exposure), or the protocol can't burn shares until settlement completes (creating double-spending and accounting problems). There's no costless solution—only different risk allocations.

Institutional Expectations: Traditional fund redemptions have similar risks (fund insolvency during redemption processing). Institutional investors may accept this as normal operational risk, while retail users may expect blockchain "trustlessness" to eliminate it.

Regulatory Clarity: Securities regulations don't clearly address on-chain/off-chain settlement gaps. Protocols must design for regulatory uncertainty while protecting users.

Understanding naked redeemer risk is essential for anyone building, auditing, or investing in RWA vaults. The risk is inherent to asynchronous settlement architecture—it cannot be eliminated, only mitigated through careful mechanism design, appropriate timeouts, and clear user communication about exposure during the settlement window.