Overview:
Competition in the Lending sector is fierce — Since Aave’s v1 launch in 2020, 75+ lending platforms have gained $100m TVL at peak through aggressive growth tactics (E.g Liquidity Mining). Despite this, Aaves’ commitment to balancing safety and innovation has cemented their place as market leader, showing consistent market dominance of around 30-40%. Throughout multiple market cycles, Aave has has shown its resilience and capabilities.
Aaves’ dominance can be attributed to their consistent protocol upgrades:
Aave v1: Pooled risk with two supported assets (ETH and LEND).
Aave v2: Multi asset support (DAI, USDC, USDT, WBTC) with protocol based liquidations.
Aave v3: Single borrowable asset, Isolation modes, dynamic interest rates, Emode feature.
The proposed v4 brings the following changes:
Aave v4: Cross chain liquidity, Aave network, non EVM deployment, RWAs, and an updated visual identity.
We are happy to support the new proposal for v4, and believe this will continue to ensure Aave is cemented as market leader. In specific, we believe the Aave v4 proposal targets two specific factors which are vital to the long term success of Aave.
Increasing Aaves’ Market Share
Fragmented Liquidity: In recent years we have seen efforts to improve infrastructure to make Ethereum more scalable. While this led to the emergence of Layer 1 and Layer 2 scaling solutions, the side effect was fragmentation of liquidity. In 2020 when Aave launched the majority of TVL was on Ethereum Mainnet - Today TVL is spread across various Layers 1s (Ethereum $52b, BSC $5b, Tron $7.8b) and Layer 2s (Arbitrum $2.4b, Optimism 860m, Blast $1.4b). This has lead to the following drawbacks for Aave:
- Cross Chain deployments: To remain competitive on different ecosystems, Aave must deploy on multiple chains. This requires initial deployment costs and overhead effort for the DAO and risk team. Each deployment requires a formal governance process, and additional governance is required for adding markets and adjusting risk parameters. Currently Aave has deployed on 10+ different chains.
- Fragmented Liquidity: The interoperability of assets is limited. Collateral is chain specific, users are limited to borrowing on the same chain they have deposited their collateral. Pooled collateral and Assets Liquidity is also chain specific, meaning lack of Native LPs can become a bottle neck for listing new markets. Due to these reasons Aave is still most popular on ETH L1 with 87% of TVL - even despite the high gas fees.
With the emergence of the Chainlink Cross-Chain Interoperability Protocol, the issue of liquidity fragmentation is greatly improved. CCIP allows for Cross-chain lending, allowing users to borrow any asset on Aave v4 and use it across chains. This gives Aave the following upgrades:
- Interoperability: The proposed Unified Liquidity Layer creates independent and abstracted infrastructure for borrowing assets. With the new Aave Network, Aave becomes the primary hub for cross chain liquidity.
- Less overhead: Reduced overhead costs of deployment and maintenance of Aave across various ecosystems.
- Market Dominance: Currently there is a trend that each chain has a dominant lending platform which bootstraps itself with high incentives. As a result, Aave is required to remain competitive by launching early on new ecosystems. With a cross-chain Liquidity hub proposed with v4, Aave can disrupt this trend and become the leader across all chains without requiring specific deployment strategies.
Non EVM chains: In addition, Non EVM chain are emerging as alternatives to Ethereum. Currently there is no deployment of Aave on non EVM chains, due to Aaves’ core contracts being written in Solidity. While launching on EVM chains requires forking the code to a new chain, a non EVM deployment would require the smart contracts to be rewritten.
Despite this it is clear that Non-EVM chains represent an untapped market for Aave. By launching a Non-EVM deployment Aave taps into billions of TVL previously not possible.
Real World Asset Strategy: At Keyrock our vision is that all assets will eventually become digital. With its bluechip status and ≈10b Value Locked, Aave is extremely well positioned to enable the linking between traditional financial markets with on-chain assets. We are interested to see this play out and can imagine the a future where users can:
- Borrow Fiat against Crypto collateral
- Earn interest on US treasury bonds via lending
- Gain exposure to commodities via Aave
RWAs represent vast untapped potential, and these examples represent only a few possibilities that Aave can unlock with their RWA integrations.
New Brand Identity: User experience becomes a crucial factor when onboarding the new cohorts of crypto users. Our subjective opinion is the design is incredibly well done and an improvement for the brand identity of Aave.
Bolstering GHO:
Introduced in 2023, GHO is a Over-collateralized Stablecoin backed by yield bearing assets on Aave. GHO is still in its early stages with a supply of 49m, and the mint caps are set manually by the GHO steward team.
Currently roughly half ($23m) of this amount is staked in the Aave safety module. GHO staked in the safety module will be used as mitigation in the event of a short fall event, in return stakers get stAAVE incentives. These incentives are currently 100 stAAVE / Day (13% APR).
However the limitations of this design are as follow:
- Scalability: The current Aave Safety Module GHO pool is incentivised by stkAAVE rewards. This strategy has limitations due to the inverse relationship between TVL and APR (as TVL increases APR goes down). The only way to scale would be to increase stAAVE rewards which increases emissions and costs for Aave.
- Incentive based demand: Incentive based demands is volatile as demand for GHO only exists as long as incentives are high enough. Constant incentives are required to sustain the demand for GHO. A more suitable strategy is create integrations and usecases to create sustained demand.
Aave v4 proposes the following uses-cases / improvements for GHO:
- GHO will be the native coin which pays for fees on the proposed Aave Network.
- Suppliers can opt in to receive Stablecoin interest in GHO.
- Lending Liquidating AMM is proposed to ease GHO liquidations by liquidating collateral to GHO. This can then be used to buy back any asset available in Aave. During this GHO earns interest.
- The introduction of at least one Aave Labs product to propel growth of Aave/GHO.
- GHO will be utilised for the RWA project.
Additionally we support the additional improvements suggested in the development proposal:
- Fuzzy controlled interest rates → Reduces overhead for the DAO and risk teams. Automates current manual governance procedures relating to parameter changes. Increases security through faster response time.
- Liquidity Premiums → Improves capital efficiency of the protocol by creating interest rate tranches based on liquidity.
- Smart accounts → Allows the creation of various smart accounts using the same wallet. This feature also enables vaults which enable segregation of risk by allowing users to borrow without supplying collateral to pooled liquidity.
- Automatic Off-boarding → Current process to off-board collateral requires constant governance process for each incremental change to parameters (RF, LT) and can cause liquidations. The off-boarding process automates this process.
Regarding the proposed funding the current Aave costs are around $12m / year. With an Annualised fee revenue of $65m / year, Aave is operating at a net profit of ≈50m / year. In addition to this, the Aave treasury has around $50m in assets.
Based on the financial health of the protocol we believe the proposed payment to be a necessary and justified investment for the DAO. Needless to say, we are huge supporters of this proposal.