Summary
LlamaRisk fully supports the proposed Aavenomics implementation. This proposal represents a significant evolution of the Aave protocol. The ARFC provides visibility on fundamental changes while appropriately deferring implementation specifics to relevant service providers.
We’re honored to be proposed as part of the Aave Finance Committee and are confident we can contribute with our Umbrella capitalization methodology. The proposed mechanisms for staking, revenue distribution, and buybacks are technically sound and well-aligned with the protocol’s growth objectives.
Given the evolving regulatory landscape for DeFi protocols, we’ve dedicated the remainder of our response to a focused legal analysis through the lens of European regulatory frameworks, particularly MiFID II and MiCA, examining key aspects of the proposal that may have regulatory implications. This analysis provides additional context for community decision-making but does not constitute formal legal advice.
Legal analysis
This brief provides key insights on the potential legal ramifications of this update:
Staking
ESMA and EBA are examining how staking aligns with lending services in DeFi. For Aave, assets are immobilized to cover potential shortfalls, with users receiving clear disclosures on rewards and slashing risks. Our analysis concludes Aave provides sufficient consumer protection through transparent documentation and (soon to be) programmatically enforced DAO-administered slashing mechanisms.
Detail analysis
Detail analysis
In the European Union, the regulatory approach toward staking remains in flux as authorities continue to evaluate its risks and impact. The European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) have focused on scrutinizing “staking-as-a-service” offered by centralized trading platforms.
In a recent Joint Report, these authorities are investigating how staking interacts with borrowing and lending services under the Markets in Crypto-Assets Regulation (MiCA). They seek to understand how lending, borrowing, and staking operate in DeFi ecosystems, how yields are shared, what disclosures are provided, and what protections exist in adverse scenarios like token slashing.
While this research doesn’t constitute formal legislation, it signals authorities’ perspectives and potential future regulatory developments.
For this report, “staking” is defined as “the process of immobilizing crypto-assets to support the functioning of PoS and PoS-like blockchain consensus mechanisms, in exchange for the conferral of validator privileges that can yield block rewards” per a Commission Q&A on staking and MiCAR. The French AMF adopts a similar definition.
In staked aTokens, assets are immobilized to safeguard against shortfall events. Participants receive rewards in AAVE tokens or other approved incentives by assuming slashing risk. This design both compensates stakers and strengthens protocol security by providing reserves to offset potential losses.
Slashing in this context differs from its use in PoS networks. Within the Aave Safety Module, slashing means reducing staked assets during a protocol shortfall to cover resulting deficits.
Regulators are primarily concerned about consumer protection—specifically that participants may be inadequately informed about terms and conditions. This concern appears mitigated for Aave, as reward structures and slashing risks are extensively explained in the official documentation. The user interface displays risk notices and directs users to additional resources in non-technical language.
Source: Aave - Open Source Liquidity Protocol, Date: March 5th, 2025
Another concern is potential misuse of staked assets. Participants receive staked tokens recalculated based on the prevailing exchange rate, representing their share in the Safety Module. While starting at 1:1, this ratio evolves with slashing events or capital inflows. Users can verify this ratio on-chain through EXCHANGE_RATE_UNIT.
Slashing is the only way users can lose funds, and only addresses with the SLASH_ADMIN_ROLE can initiate it. This role is controlled by the DAO via the ExecutorLvl1 contract at address 0x5300A1a15135EA4dc7aD5a167152C01EFc9b192A. This “short executor” implements governance-approved measures for less risky proposals with shorter timelocks.
The maximum percentage of stAAVE that may be slashed is 30% of total staked holdings.
Based on this analysis, Aave mitigates consumer protection risks by providing comprehensive information on staking mechanics, purpose, anticipated rewards, and participation risks.
Revenue distribution
Under MiFID II, a crypto-asset is a financial instrument only if it is not a payment instrument, constitutes a security class, and trades freely on capital markets. AAVE serves a governance function rather than payment, meeting the first criterion. While AAVE trades on exchanges, it primarily grants protocol governance rights, not corporate governance powers typical of securities. Furthermore, cooldown periods restrict transferability. As AAVE must satisfy all three criteria to qualify as a transferable security, it fails to meet either the security class requirement or transferability standard.
Detail analysis
Detail analysis
AAVE token holders can stake their AAVE within the staking module, obtain staked AAVE (stkAAVE) as proof of deposit, and accrue additional AAVE derived from protocol revenue through the upcoming “buy & distribute” initiative. The Aave collector, holding the protocol’s net revenue, will allocate funds to the ecosystem reserve and distribute rewards to the staking module, reaching stkAAVE holders through this model.
A key legal concern is whether allocating protocol revenue to token holders could classify the tokens as securities. In many jurisdictions, if holders realize profits primarily attributable to external parties’ labor (like developers), the token may be deemed a security, subjecting the protocol to rigorous compliance obligations.
In the European Union, ESMA has issued guidance on categorizing crypto-assets as financial instruments under MiFID II. A crypto-asset will be classified as a financial instrument if it qualifies as a transferable security by meeting three conditions: it is not an instrument of payment, it represents a “class of securities”, and it is negotiable on the capital market.
Not being an instrument of payment
A crypto-asset is excluded from being an instrument of payment if not used as a medium of exchange. The AAVE token serves a governance function rather than a payment medium, likely fulfilling this criterion.
Being “classes of securities”
ESMA notes that crypto-assets conferring corporate voting privileges (electing board members, approving mergers) are more like shares. Conversely, crypto-assets whose governance rights concern only technical adjustments (protocol upgrades, fee modifications) lack traditional shareholder features and should not be considered securities.
Aave documentation specifies that AAVE and stkAAVE holders can vote on proposals or delegate voting power for protocol deployments, parameter modifications, and new features. These attributes don’t align with ESMA’s definition of a security class, making AAVE unlikely to meet this criterion.
Being negotiable on the capital market
A crypto-asset must be freely transferable to satisfy negotiability. While AAVE is listed on various exchanges, staking introduces limitations: users must start a cooldown interval (48 hours) to withdraw tokens, followed by a limited window (another 48 hours) to redeem them. Missing this window resets the cooldown. These lock-up provisions create substantial barriers to seamless transfer.
To qualify as a transferable security, an asset must satisfy all three criteria. Since AAVE doesn’t meet the conditions for being a security class and has transferability restrictions, it cannot be conclusively deemed a transferable security.
Furthermore, AAVE doesn’t qualify as other financial instruments:
- It lacks a predefined maturity or redemption date (money-market instrument)
- It doesn’t pool capital for a specified investment strategy (collective investment undertaking)
- It’s not designed as a predetermined sale arrangement (derivative contract)
- It confers no emission rights under the EU Emissions Trading System
Buybacks
Buyback programs may appear manipulative if they artificially influence price or volume. However, Aave’s proposed approach is transparently debated in governance, proceeds only via publicly approved proposals, and executes in a manner preventing concealed manipulation, significantly reducing exposure to MiCA’s market manipulation rules.
Detail analysis
Detailed analysis
Buyback initiatives pose legal vulnerabilities under MiCA’s market manipulation rules. A program could be deemed manipulative if it artificially influences a crypto-asset’s price or trading volume. MiCA prohibits transactions or conduct creating false signals regarding supply, demand, or price, as well as deceptive public communications. These prohibitions apply to all individuals and entities, as Article 91(1) states: “No person shall engage in or attempt to engage in market manipulation”.
Aave’s program structure provides strong counter-arguments to potential MiCA claims. Purchases occur on the open market or through arrangements with market makers, ensuring transparency. The ALC can only conduct buybacks under treasury management AIPs, each requiring thorough public discussion through governance forum, temp check, and ARFC phases before execution. Nothing is concealed from public scrutiny, making the token acquisition process fully transparent.
Given that the buyback measures are executed through a genuinely decentralized process relying on DAO architecture, MiCA’s scope may not extend to them. Therefore, proceeding with AAVE purchase orders or transactions likely won’t subject the DAO to significant risk of violating MiCA’s market manipulation provisions.
Disclaimers
All preceding observations constitute a broad overview of current legal instruments and regulatory guidance from competent authorities. This information aims to enhance Aave stakeholders’ understanding of the legal environment and aid decision-making when voting on issues with legal implications.
Nothing presented here should be interpreted as legal counsel or a definitive legal stance on referenced regulations, including MiCA, MiFID, or other applicable provisions.
This discussion does not preclude the DAO from seeking additional advice from legal professionals to obtain formal opinions on these subjects.