[ARFC] Update AAVE Token LTV/Liquidation Percentages

[Leritu]

[ARFC] Update AAVE LTV and Liquidation Threshold Percentages

Author: Leritu

Date: 2025-02-07

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Simple Summary:

This ARFC seeks the community’s input on adjusting AAVE’s LTV percentage from 66% to 71% and the liquidation ratio from 73% to 78%

Motivation

Aave’s token (AAVE) has meaningfully grown in its liquidity, market capitalization, and market share in the DeFi space. As a result of these meaningful gains, a modest upward adjustment to AAVE’s ratios is worth considering.

A higher Loan-to-Value (LTV) and Liquidation Threshold (LT) can improve capital efficiency for AAVE holders, allowing them to access greater borrowing power without significantly increasing systemic risk. This change aligns with AAVE’s broader goal of maintaining a competitive and sustainable lending environment. Additionally, similar assets with comparable liquidity and adoption levels already operate at or above the proposed thresholds, reinforcing the prudence of this adjustment.

To be clear – we do not want to create excess endogenous collateral risk by moving the LTV and Liquidation ratios too high. With that balance in mind, the proposed percentages are not aggressive. Indeed, the newly proposed 71% LTV and 78% liquidation percentage is still meaningfully below other more liquid and mature collateral.

Specification:

This proposal will achieve the following:

• Increase Aave token’s LTV from 66% to 71%
• Increase Aave token’s liquidation threshold from 73% to 78%

ARFC updated with Risk Parameters 2025-02-14

Instance	Asset	Current LTV	Rec. LTV	Current LT	Rec. LT
Ethereum Core	AAVE	66.0%	69.0%	73.0%	76.0%
Arbitrum	AAVE	63.0%	66.0%	70.0%	73.0%

Disclaimer:

I am a larger supplier of over 100,000 AAVE tokens into the platform with stablecoins (GHO) borrowed against that collateral.

Next Steps

1. If consensus is reached on this [ARFC], escalate this proposal to the Snapshot stage.
2. If the ARFC snapshot outcome is YAE, publish an AIP vote for final confirmation and enforcement of the proposal.

Copyright:

No claims to copyright with this post.

[Terminal]

A recurrent criticism over DAO tokens is that they have no use case outside voting, in the case of the AAVE token, this can change by transforming it into a premium collateral within the AAVE market.

Personally, I would be more aggressive in increasing the numbers, but I understand this can be seen as too risky.

This approach could also be adopted into GHO to stimulate growth and adoption when the DAO feels confident in enabling it as collateral.

[MarcZeller]

Hello,

Having excessive “endogenous” collateral in a lending protocol is generally frowned upon, and granting larger borrowing power to AAVE might lead to harsher liquidations and more pronounced token price declines during market downturns.

That said, AAVE is one of the most liquid governance tokens in DeFi. The acceptable liquidity levels and market data (which our risk team will provide in this thread) suggest that AAVE token holders typically maintain a high health factor, and that AAVE collateral represents only a nominal percentage of the protocol’s debt compared to other assets.

I’m not sure if the suggested parameters are the correct ones. Still, I believe it’s worthwhile to have our risk team assess the proposal and, if deemed acceptable, update our risk parameters accordingly.

I updated this proposal to ARFC as risk parameters update of already onboarded assets doesn’t require a TEMP CHECK.

Disclaimer:

This should come as no surprise. I’m a “reasonably sized” AAVE token holder and stand to benefit from this proposal.

[LlamaRisk]

Summary

LlamaRisk endorses an increase in AAVE’s LT/LTV parameters, originally set in 2023 during the Aave V2-to-V3 migration. By raising these limits, the protocol can unlock greater borrowing capacity for its users without significantly increasing risks. After thoroughly reviewing asset utilization and liquidity metrics, we conclude that these adjustments can be implemented safely.

While expanding borrowing capacity against a protocol’s native token is typically discouraged, current market usage and robust liquidity support a cautious relaxation of these parameters. Moreover, AAVE is an excellent candidate for integration with the Umbrella system, which enables secure optimization of individual reserves via siloed insurance funds. Asset usage will be monitored continuously to ensure liquidation events remain reasonably profitable under all market conditions.

Current Asset Usage

The AAVE market on V3 Core is currently at 59.47% of its supply cap, with 1.10M tokens (approximately $270M) being supplied. This market is relatively stable in terms of supply variability.

Source: Aave Token Market, Aave App, February 9, 2025

More than 75% of the borrows against this asset are in stablecoins, with USDC leading, GHO in second place, and USDT in third. Approximately 97% of the assets borrowed against AAVE consist of USD stablecoins or BTC wrappers. These assets exhibit lower volatility than more niche assets, thus reducing the risk of unintended liquidation.

Source: Borrow Distribution for Aave, Chaos Labs Community Analytics, February 9th, 2025

Source: Large Position Analytics, Chaos Labs Community Analytics, February 9th, 2025

AAVE borrowers are very conservative. Larger AAVE positions are heavily overcollateralized and generally insulated from intraday market volatility. The most aggressive borrowers typically utilize alternative collaterals (e.g., WETH and rETH as used by 0xa2e4) to hedge against liquidation risk.

Source: AAVE Value at Risk by Chain, Chaos Labs Community Analytics, February 9th, 2025

This results in limited risk exposure should the market price of AAVE decline rapidly. Under current conditions, only approximately $2.5M would be liquidated if AAVE’s price dropped by 25%. In contrast, the WBTC market could see around $70M liquidated with the same percentage decrease.

As an asset with a large market cap, AAVE has not experienced a 50% or greater price decline in a single day since 2021. Consequently, it is unlikely to undergo the volatility required to trigger massive liquidations in the short term.

Source: Messari, February 10th, 2025

Source: AAVE to ETH Token Swap Modelling, DeFiLlama Liquidity, February 9th, 2025

AAVE on-chain liquidity is robust, with a $32M trade having approximately a 7.5% impact. This indicates that AAVE’s current supply cap is roughly 8.5 times its market liquidity, which could pose challenges if borrowers become significantly more aggressive with their positions. As noted in Chaos Labs’ Value at Risk modeling, even a 50% decrease in AAVE’s price would only result in around $25M coming into the liquidation range—an amount that current market liquidity can absorb.

Risks of This Change

This new parameter adjustment introduces primarily an economic risk. As noted by @MarcZeller leading DeFi platforms typically avoid undue exposure to their native governance token. Such risk arises because significant token price fluctuations can trigger deleveraging spirals if market participants lose confidence in the protocol. Similar scenarios have been observed in DeFi, most notably during the Terra/Luna collapse.

In the context of Aave, such fluctuations could generate bad debt, further depreciating the token’s value as more participants exit their positions—even before the AAVE-reliant safety module is activated. This would undermine the effectiveness of over-collateralization across the entire protocol. Although integration with the Umbrella system helps mitigate contagion risk through insurance segregation, bad debt may still be generated, potentially leaving depositors unable to withdraw their assets. Supply sinks, such as stkAAVE (soon to be deprecated), Balancer, and Uniswap LPs, generally help mitigate this.

Source: Aave V3 Total Liquidations, Kartoid via Dune, February 10th, 2025

The likelihood of this risk materializing is low. AAVE users generally maintain high health scores, as historical data shows that liquidations account for less than 5% of Aave V3 Core events. Furthermore, robust market liquidity ensures that even a trade volume five times the total of Aave V3 liquidations would enable liquidators to acquire positions profitably.

Aave V3 Specific Parameters

We endorse the LTV and LT parameters proposed by user @Leritu, which maintain a 7% differential between the two values.

Parameter	V3 Core Instance	Arbitrum
Isolation Mode	False (unchanged)	False (unchanged)
Emode	N/A (unchanged)	N/A (unchanged)
Borrowable	False (unchanged)	False (unchanged)
Borrowable in Isolation	False (unchanged)	False (unchanged)
Collateral Enabled	True (unchanged)	True (unchanged)
Stable Borrowing	False (unchanged)	False (unchanged)
Supply Cap	1.85M (unchanged)	36K (unchanged)
Borrow Cap	N/A (unchanged)	N/A (unchanged)
Debt Ceiling	N/A (unchanged)	N/A (unchanged)
LTV	66% → 71%	63% → 68%
LT	73% → 78%	70% → 75%
Liquidation Bonus	7.5% (unchanged)	10% (unchanged)
Liquidation Protocol Fee	10% (unchanged)	10% (unchanged)
Reserve Factor	0% (unchanged)	0% (unchanged)
Base Variable Borrow Rate	0% (unchanged)	0% (unchanged)
Variable Slope 1	7% (unchanged)	7% (unchanged)
Variable Slope 2	300% (unchanged)	300% (unchanged)
Uoptimal	45% (unchanged)	45% (unchanged)

We do not recommend modifying AAVE’s parameters on Arbitrum (with $9.42M AAVE supplied), OP (2.11M AAVE supplied), or Polygon (16.43M AAVE supplied), as the potential benefits are marginal.

Disclaimer

This review was independently prepared by LlamaRisk, a community-led non-profit decentralized organization funded in part by the Aave DAO. LlamaRisk is not directly affiliated with the protocol(s) reviewed in this assessment and did not receive any compensation from the protocol(s) or their affiliated entities for this work.

The information provided should not be construed as legal, financial, tax, or professional advice.

[MarcZeller]

we are in favor of replicating changes on Arbitrum to reflect our alignment with this L2 and encourage Aave users migration from Polygon to a more friendly L2.

[LlamaRisk]

@MarcZeller

we are in favor of replicating changes on Arbitrum to reflect our alignment with this L2 and encourage Aave users migration from Polygon to a more friendly L2.

We also support increasing the LTV and LT on Arbitrum if it serves a strategic purpose. We note that there is approximately $1.3M worth of liquidity within the liquidation bonus (10%).

Source: AAVE to ETH Token Swap Modelling, DeFiLlama Liquidity, February 11th, 2025

We also note that the supply cap might need to be raised if users transition to Arbitrum to benefit from more permissive parameters. In such a case, current liquidity provision indicates that a supply cap increase would be feasible.

Source: onaave, February 11th, 2025

Below we show a simulation of a 30% AAVE drawdown under current (70%) and proposed (75%) LT.

Simulation of 30% drawdown at current LT (70%), Chaos Labs, February 11th, 2025

Simulation of 30% drawdown at proposed LT (75%), Chaos Labs, February 11th, 2025

We will update our proposed parameters in the original recommendation.

[ChaosLabs]

Summary

Chaos Labs supports the proposal to increase AAVE’s LTV and LT on the Ethereum Core and Arbitrum V3 instances. However, we recommend different parameters.

Analysis

As detailed, while AAVE is the native token of the Aave protocol, introducing additional reflexivity risks, it is also a relatively liquid asset that has served as high-quality collateral. As it stands, the largest risk of collateralizing AAVE is its inclusion in the Safety Module, the anticipated or realized usage of which would likely stress the AAVE token and coincide with events that stress the protocol and token. However, this risk surface will soon be mitigated following the implementation of Umbrella.

Additionally, AAVE’s market cap and DEX liquidity have shown significant growth since the time of its initial listing and since the current parameterization has been determined. Its buy-side liquidity currently accounts for $50M of WETH, which is largely represented by the ABPT staked in the safety module, while its market cap has grown more than three-fold from $1.1B in April 2023 to $3.8B today.

While some of the additional liquidity has been driven by the price increase of the asset, AAVE’s volatility has remained fairly consistent over the last 365 days, with its 30-day Daily Annualized Volatility currently being 116%. And its biggest price drop over the same timeframe was 17.25%.

On Ethereum, $88M is borrowed against $281M AAVE supplied; the majority of this is in highly liquid stablecoins.

On Arbitrum, users are borrowing $3M against $7.8M AAVE supplied. Again, the majority of value borrowed is in stablecoins, particularly USDC.

Additionally, we find that AAVE’s price impact has been stable or decreasing on Ethereum and Arbitrum over the last 90 days.

Considering a 99th percentile price and liquidity drop in the AAVE token, our risk simulations indicate that the asset’s LT can be increased across Ethereum and Arbitrum and should not be increased in other instances that express minimal on-chain liquidity. By analyzing volatility, liquidity, and user behavior, our findings show that the protocol can increase LT by 3 percentage points on Ethereum and Arbitrum without leading to a rise in Value at Risk (VaR). Given AAVE’s inherent volatility and the associated parameterization applied to other, less volatile assets, it is prudent for Aave’s risk framework to reflect this balance.

The proposed recommendation is outlined below.

Specification

Instance	Asset	Current LTV	Rec. LTV	Current LT	Rec. LT
Ethereum Core	AAVE	66.0%	69.0%	73.0%	76.0%
Arbitrum	AAVE	63.0%	66.0%	70.0%	73.0%

Disclaimer

Chaos Labs has not been compensated by any third party for publishing this recommendation.

Copyright

Copyright and related rights waived via CC0

[ACI]

Thank you @ChaosLabs and @LlamaRisk.

Current proposal has been escalated to ARFC Snapshot vote will start tomorrow, we encourage everyone to participate.

[Jadmat]

I recommend reviewing the AAVE supply limits; in Arbitrum, he is constantly close to the limit (36,000 AAVE), the AAVE supply in Arbitrum chain is 65,400 AAVE; Optimism, for example, has a limit of 45,000 AAVE with a circulating supply of 12,700 AAVE; the parameters seem to be set and forget.
Increasing the LTV by limiting the supply seems to be an injection of risk with a limited return.

[Michigan_Blockchain]

As Michigan Blockchain, we support updating AAVE LTV and Liquidation Threshold Percentages, specifically adjusting AAVE’s LTV percentage from 66% to 69% and the liquidation ratio from 73% to 76% on Ethereum Core; and LTV percentage from 63% to 66% and the liquidation ratio from 70% to 73% on Arbitrum.

First of all, an increase in LTV will result in higher borrowing power, helping users to get access to more capital without adding new collateral. This will lead to greater capital efficiency, assuming that the increase in these parameters does not pose extensive additional risk. We don’t think that the increase in LTV and LT will cause a great protocol risk for 2 reasons. 1) The type of borrowed assets against AAVE token, and 2) AAVE token collateral positions being overcollateralized.

Let’s look at the most commonly borrowed assets against AAVE on Ethereum mainnet.

Distribution of borrowed assets against AAVE, in USD

Over 80% of the borrows are in stablecoins, and the other 16% in forms of wrapped BTC, leaving only 4% to the rest. Given that stablecoins are the most “stable” asset by definition, and BTC being the most stable outside outside stablecoins, almost all borrows against AAVE tokens are in very stable and relatively non-volatile assets. This borrowing behavior indicates that there is a relatively lower risk of liquidations happening, so an increase in LTV and LT are feasible.

Also, for extensive liquidations to occur, AAVE token price has to drop by a lot. If the token price drops to $173, only $2.5m value will be liquidated.

Aave token value at risk of liquidation in positions with health score approaching 1

Compared to the $300m Aave value that is currently supplied on Ethereum mainnet, $2.5m in liquidations will not pose a great threat. It is very unlikely for AAVE token price to drop that much suddenly, so collateral position holders will have the time to reorganize their positions in case of a black swan event.

Also, increasing LT will result in increased liquidation buffer, making it safer for borrowers in a volatile market. Given Aave’s growing liquidity and increasing adoption, we believe that raising these parameters slightly will enhance capital efficiency for its users. This will also ensure the protocol is safe. Many similar DeFi assets already have comparable or higher LTV/LT ratios. This proposal will bring Aave in line with industry standards without introducing unnecessary risk.

Although we understand that this also poses an economic risk and could lead to bad debt for Aave, we believe that it is quite unlikely. We agree with LlamaRisk’s research and point about AAVE users maintaining a high health score. By allowing users to borrow more against Aave, this change will benefit the broader DeFi ecosystem. We believe that the new values for LTV and LT are properly measured and this adjustment will enhance the capital efficiency and borrowing conditions, while also maintaining Aave protocol’s security. Also, we are aware that the statistics on the Arbitrum market is slightly different, but in terms of supporting the argument for changing LTV and LT, same ideas that the type of borrowed assets against AAVE token are not volatile and that AAVE token collateral positions are overcollateralized is true just like the Ethereum Core.

-Kerem Dillice and nsks

[ACI]

After Snapshot monitoring, the current ARFC Snapshot has PASSED, reaching both Quorum and YAE as winning option with 758.8K votes.

Next step will be the publication of an AIP for final confirmation and enforcement of the proposal.

[Leritu]

Just following up here. Who escalates this to the next step for implementation?

[ACI]

Hi Leritu, ACI already internally escalated. Nothing to do now, we’ll ping when AIP is live.