From ETHLend to Aave V4: The Evolution of Decentralized Lending

Student Author | @Elias201179

Mentor | @CryptoScott_ETH

First Published | 2024.5.21

• Aave is a multi-chain lending protocol, primarily focused on P2C (peer-to-contract) lending of crypto assets through dynamic interest rate models and liquidity pools. Currently, its total value locked (TVL) ranks third among DeFi projects, particularly leading in the lending category. Aave's parent company, Avara, is gradually expanding into new areas, including cross-chain lending, stablecoins, open social protocols, and institutional lending platforms.
• The total supply of AAVE tokens is 16 million, with 13 million allocated to token holders and the remaining 3 million reserved for the Aave ecosystem. Currently, the total circulating supply of AAVE tokens is approximately 14.8 million.
• As Aave's business continues to expand and mature, both its TVL and price have increased amid a market recovery in 2024. In May, Avara announced the upgrade plan for Aave V4, focusing on further enhancing Aave's liquidity and asset utilization.
• The Aave V3 version has largely replaced the V2 version, and the stabilization of its business model and user base has allowed Aave to far surpass other lending protocols in terms of TVL, transaction volume, and the number of supported chains.
• Avara has faced some challenges in expanding its business. Currently, its main revenue still relies on traditional lending. The stablecoin GHO has recently regained its peg after a period of de-pegging. The TVL of the institutional lending platform Aave Arc has remained low after a significant drop.
• For Aave's future development, recommendations include further optimizing its cross-chain lending solutions, strengthening its stablecoin business and deeply integrating it with the Aave platform, incorporating Aave's DeFi capabilities into emerging businesses like social platforms, and integrating currently relatively independent business segments into a comprehensive ecosystem.

In the first quarter of 2024, the DeFi market showed significant growth and vitality, with both fees and revenue reaching annual highs. The DeFi market generated over $1.6 billion in fees and over $467 million in total revenue last quarter, with March alone reaching $230 million in revenue, setting a new high for the year.

Lending, as one of the core functions of the cryptocurrency ecosystem, uses smart contracts to match lenders and borrowers, lock assets, calculate interest, and execute repayments. According to defillama data, as of mid-May 2024, the total TVL in the lending sector reached $29.586 billion, accounting for 36% of the entire DeFi sector's TVL.

In this context, Aave, as a key player in the DeFi lending market, is particularly noteworthy. Aave's total borrowing volume in the first quarter of 2024 reached $6.1 billion, a 79% quarter-over-quarter increase, far exceeding the market average growth rate.

Additionally, Aave's lending revenue grew by 40% this quarter, reaching $34.9 million, maintaining its leading position in the DeFi lending market. Despite fierce competition from rivals, Aave continues to dominate in terms of TVL and revenue.

Studying Aave's performance in the DeFi market is also crucial for understanding the overall development trends and future potential of the DeFi market. Aave's success story and operational model offer valuable insights and lessons for other DeFi projects.

In May 2017, Stani Kulechov founded the ETHLend project. Initially, ETHLend faced severe liquidity challenges during its operation. By the end of 2018, ETHLend underwent a strategic transformation, shifting from a P2P (peer-to-peer) model to a P2C (peer-to-contract) model, introducing a liquidity pool model, and officially rebranding to Aave. This transformation marked Aave's official launch in 2020.

In November 2023, Aave Companies announced a rebranding to Avara. Avara gradually introduced new businesses, including the stablecoin GHO, the social network protocol Lens, and the institutional lending platform Aave Arc, and began strategic deployments in multiple fields such as crypto wallets and gaming.

Currently, the Aave V3 version is stably in use, with its services expanded to 12 different blockchains. Meanwhile, Aave Labs is further attempting to upgrade the lending platform, announcing the V4 version upgrade proposal in May 2024.

According to Defillama data, as of May 15, 2024, AAVE ranks third in the DeFi (decentralized finance) sector with a total TVL of $1.0694 billion.

Aave's parent company, Avara, is headquartered in London, UK, initially formed by an innovative team of 18 people. Currently, LinkedIn shows a total of 96 employees.

• Founder and CEO: Stani Kulechov holds a Master of Laws degree from the University of Helsinki, with a thesis on using technology to improve the efficiency of commercial agreements. He is also an experienced Web 3 entrepreneur.
• COO: Jordan Lazaro Gustave started coding in his teens and holds a Master's degree in Risk Management from University Paris X Nanterre.
• CFO: Peter Kerr graduated from Massey University and the University of Oxford, previously working at HSBC, Deutsche Bank, and Sonali Bank, and joined Avara as CFO in 2021.
• Head of Institutional Business: Ajit Tripathi graduated from IMD Business School and the Indian Institute of Technology, previously working at Binance, ConsenSys, and PwC.

• In 2017, ETHLend raised $16.2 million through an ICO, during which Aave Companies sold 1 billion units of LEND tokens.
• In 2018, the project rebranded to Aave.
• In July 2020, Aave secured $3 million in Series A funding led by Three Arrows Capital.
• In October 2020, Aave secured $25 million in Series B funding and launched the governance token $AAVE.
• In May 2021, the AAVE protocol was deployed on Polygon, receiving $200 million worth of Matic lending mining rewards from Polygon within a year.

Figure 1: Aave Historical Events

Major events and announcements often significantly impact the price and total value locked (TVL) of decentralized lending protocols. For example, after the launch of Aave V2 at the end of 2020, both the price and TVL of AAVE saw a significant increase. This trend continued during the DeFi Summer of 2021, as the scale of collateral and lending in lending protocols continued to expand, leading to further growth.

持了 Aave 的高价格水平。到了 2022 年 3 月，Aave V3 的推出再次推动了 AAVE 价格和 TVL 的明显增长。然而，随后发生的 UST 脱钩事件以及随之而来的熊市，导致了 AAVE 的 TVL 整体缩水以及价格下跌。

尽管在 2023 年 11 月 5 日，Aave 收到关于 Aave 协议功能问题报告、临时暂停 Aave V2 市场交易后，导致了 AAVE 价格和 TVL 的短期下降。但随着整体市场向好，且 GHO 逐步恢复锚定，AAVE 的价格和 TVL 在近期出现了明显的上涨趋势。

图 2: Aave价格历史事件图

图 3: Aave TVL历史事件图

自 2020 年 1 月 Aave 首次亮相以来，它凭借其借贷池、aToken 模式、创新的利率机制以及闪电贷功能等核心特性，在去中心化金融（DeFi）领域确立了其重要地位。随着 Aave 从 V1 演进至 V3，其借贷业务模式展现了持续稳健的发展态势。

在 2020 年 12 月，Aave 发布了 V2 版本，该版本通过简化和优化其架构，并引入了债务代币化和闪电贷 V2 等功能，显著提升了用户体验。根据官方白皮书，V2的架构优化预计将减少约 15% 至 20% 的 Gas 费用。2023 年 1 月 Aave 推出了 V3 版本，它在 V2 的基础上进一步增强了资金的利用效率，整体架构变化不大。V3 版本引入了三项创新功能：高效模式（E-mode）、隔离模式（Isolation Mode）和门户（Portal）。

2024 年 5 月，Aave 提出 V4 版本提案，在新版本的设计中计划采用全新的架构，并引入统一流动性层，模糊控制利率，GHO 原生集成，Aave Network 等设计，V4 版本的相关机制的具体细节将在后续的 4.1.6 节中详细阐述。

图 4：Aave 协议V2与V3架构变化

借款利率

Aave 对每种储备都有设计了特定的利率策略（Interest Rate Strategy）合约。具体而言，在基本策略合约中定义了以下内容：

可变利率计算公式为：

通过分析利率模型我们可以发现，当当前利用率低于给定市场的最优利用率时，借款利率缓慢上升。然而，当当前利用率超过最优利用率时，借贷利率会随着利用率的提高而急剧上升，即：当交易池中流动性高时，低利率鼓励贷款；当流动性低时，高利率来维持流动性。

图 5：Aave 存款利率变化图

每个资产都有一个预定的最优利用率。基于以上的利率模型，Aave V3 根据不同资产的风险状况，分出了三种利率模型策略：

图 6：Aave V3 三种利率模型策略对比

在 Aave 的交互流程中，借贷流程如下：

• 存款方通过将代币存入 Aave 的资产池，即可获得相应的 aToken。这些 aToken 作为存款凭证，不仅证明了存款行为，还能在二级市场上自由交易和转让。
• 对于借款方，他们可以通过超额抵押或闪电贷的方式借入加密货币。当借款方准备好偿还债务时，除了需归还本金，还需支付根据资产利用率和市场供需状况计算的利息。一旦债务得到结清，借款方不仅能赎回其抵押的资产，而且与其抵押资产挂钩的aToken也将被相应销毁。

Aave 的清算机制如下：

当抵押资产的市场价值下降或借入资产价值上升，导致借款方的抵押品价值跌破既定的清算阈值时，便会触发 Aave 的清算机制。不同Token根据其风险特性，会有不同的贷款价值比率（Loan to Value, LTV）和清算阈值。在清算发生时，借款方除了要支付本金和利息，还需向执行清算的第三方支付一定比例的清算罚金（Liquidation Bonus）。

相关参数：

• 贷款价值比率（LTV）：确定借款方能借出的最大资产额度。例如，70% 的 LTV 表示，对于价值 100 USDT 的抵押品，借款方最多借款 70 USDT。
• 健康因子：反映借款头寸的安全水平，健康因子越高，说明借款方的偿债能力越强；反之，健康因子越低，偿债能力越弱。一旦健康因子降至1以下，表明抵押品可能面临清算。

• 清算阈值：设定了抵押资产价值与借入资产价值之间的最低比例。当借款方的头寸触及这个阈值时，其抵押品就有被清算的风险。

在 Aave 协议中，闪电贷（Flash Loans）是一项突破性的金融创新，它依托于以太坊交易的原子性特性：交易中的所有操作要么完全执行，要么完全不执行。这一机制使得参与者能够在无需提供抵押的情况下借入大额资产。借款人在一个区块的时间框架内（大约13秒），从Aave借入资金，并在同一区块内完成偿还，从而实现借贷过程的快速闭环。

闪电贷极大地简化了执行价格套利、自动化交易策略以及其他去中心化金融（DeFi）操作的过程，同时有效规避了流动性风险。在 Aave V3 协议中，每笔闪电贷交易的手续费为 0.05%，这一费率显著低于 Uniswap V2 的 0.3%，为用户带来了更经济的借贷选择。

Figure 7: Credit Delegation Mechanism

Aave launched the Credit Delegation mechanism in August 2020, through which depositors can delegate their unused credit limits to other users, allowing borrowers to gain additional borrowing capacity.

Additionally, in September 2020, Opium introduced Credit Default Swaps (CDS) for Aave's Credit Delegation mechanism. CDS, as a risk management tool, allows investors to transfer the risk of specific borrower defaults, adding an extra layer of protection to the Credit Delegation mechanism. The following explains the operation and implementation details of the Credit Delegation mechanism through a case provided by Aave:

Figure 8: Aave Credit Delegation Case

1. Karen, as a depositor, deposits $1 million USDT into Aave. According to Aave's settings, her annual percentage yield (APY) is 5%. As a deposit certificate, Karen receives aUSDT worth $1 million.
2. To further participate in the Credit Delegation mechanism, Karen needs to create a Credit Delegation Vault (CDV) smart contract. This contract will allow Karen to deposit aUSDT worth $1 million and set various parameters, including the credit limit. For this, Karen needs to pay a 3% ETH stability fee.
3. According to the parameters she set, Karen and Chad reach a consensus on the loan terms through the OpenLaw platform, agreeing to lend at an 8% annual percentage rate (APR). Both parties agree to the agreement and formally sign it.
4. Subsequently, Karen adds Chad's receiving address to the CDV whitelist, allowing Chad to borrow $750,000 worth of ETH from the CDV based on the credit limit without providing any collateral.
5. In this case, Karen's actual APY is calculated as the original 5% minus the 3% stability fee plus the 8% lending rate, i.e., 5% - 3% + 8% = 10%. This yield is higher than her original deposit rate through Aave. Meanwhile, Chad successfully borrows $750,000 worth of ETH without collateral and agrees to pay an 8% APR.

According to the Aave V4 protocol development proposal, Aave V4 will adopt a new architecture with an efficient, modular design, minimizing the impact on third parties and providing more convenient conditions for third-party expansion work.

Liquidity Layer

• Unified Liquidity Layer

The liquidity layer is designed based on the Portal concept of Aave V3. For example, the current Aave V2 and Aave V3 have liquidity fragmentation due to version updates, and the overall liquidity migration from V2 to V3 took a long time. The liquidity layer proposed in V4 aims to unify the management of supply and borrowing limits, interest rates, assets, and incentives, allowing other modules to extract liquidity from it. In short, when Aave DAO plans to add or remove new functional modules (such as isolation pools, RWA modules, and CDP) in the future, there is no need to migrate liquidity, and various modules only need to extract liquidity from the unified liquidity layer.

Figure 9: Unified Liquidity Layer Diagram

• Liquidity Premium

Aave V4 introduces the liquidity premium feature, which adjusts borrowing rates based on the risk status of collateral. Each asset is assigned a risk factor, dynamically adjusted based on market and external risk factors. Lower-risk assets (such as Ethereum) will enjoy lower borrowing rates, while higher-risk assets (such as altcoins) will have relatively higher borrowing costs.

Figure 10: Liquidity Premium Diagram

Fuzzy Control Interest Rates

Currently, Aave's interest rate settings not only increase governance complexity but also affect capital efficiency. The Aave V4 proposal introduces a fully automated interest rate mechanism, utilizing fuzzy interest rates to dynamically adjust the slope and inflection points of the interest rate curve. This innovative interest rate management method will allow Aave to flexibly increase or decrease the base rate based on real-time market demand, providing optimized rates for depositors and borrowers.

Figure 11: Fuzzy Control Interest Rate Diagram

Aave V4 Lending Module

Aave V4 optimizes lending-related security and user experience and simplifies governance processes by introducing a series of innovative features:

• The design of smart accounts and vaults significantly enhances user experience. Smart accounts allow users to manage multiple positions through a single wallet. The vault function implemented by smart accounts allows users to borrow without directly providing collateral to the liquidity layer. The collateral will be locked during active borrowing or liquidation events, increasing the convenience and security of user interactions.
• The V4 version also proposes dynamic risk configuration to adjust risk parameters as market conditions change. Users will be associated with the current configuration of the asset when borrowing, while new asset configurations will be provided for new users, avoiding impacts on existing borrowers. Additionally, V4 introduces an automatic delisting mechanism to simplify the asset delisting process.

Over-Collateralized Debt Protection Mechanism

Due to the risk of bad debt spreading in shared liquidity, Aave V4 introduces a new mechanism to track under-collateralized positions and automatically handle their accumulated excess debt. This mechanism sets a debt threshold, and once exceeded, the corresponding asset will automatically lose borrowing capability, preventing the spread of bad debt and protecting the shared liquidity model from contagion.

GHO Native Integration Plan

Aave V4 proposes a plan to enhance integration with GHO, aiming to improve user experience and increase the yield for stablecoin providers.

1. Native GHO Minting: The V4 version proposes efficient native minting of GHO within the liquidity layer;
2. GHO "Soft" Liquidation: Drawing on the crvUSD liquidation model, V4 introduces a Lending-Liquidation Automated Market Maker (LLAMM) to simplify the liquidation process. Users can choose to convert to GHO during market downturns or repurchase collateral during market upswings;
3. Stablecoin Interest Paid in GHO: V4 will support depositors receiving interest payments in GHO. When stablecoin depositors choose this option, interest payments will convert to V4's Protocol Controlled Value (PCV), enhancing GHO's stability and improving capital efficiency;
4. Emergency Redemption Mechanism: V4 proposes an emergency redemption mechanism to address extreme de-pegging situations. When triggered, the collateral corresponding to the lowest health positions will be redeemed into GHO and used to repay their debt.

Aave Network

Meanwhile, the Aave team has proposed the concept of the Aave Network. The Aave team envisions developing an Aave Network that can serve as the main hub for Aave and GHO. This network will be centered around Aave V4, use GHO for payments, and be managed by community voting through Aave Governance V3, inheriting network security from Ethereum. Currently, this concept is still in the design stage, and the Aave team stated they will closely monitor L1 and L2 related technologies and select the appropriate implementation plan.

The borrowing rate of the GHO stablecoin is determined by AaveDAO and can be dynamically adjusted according to market conditions to adapt to economic cycle fluctuations and changes in capital supply and demand.

The innovative features of the GHO stablecoin are mainly reflected in the following key aspects:

• Facilitator: The protocol, entity, or project that controls the minting and burning mechanism of GHO. Aave is the first facilitator of GHO.
• Bucket: The community governance sets a cap on the GHO holdings through voting. This cap is to maintain the stability and liquidity of the GHO price.
• Discount Model: The borrowing rate is adjusted based on the holdings of stkAAVE, providing a discount model.

The update of Aave V3 has also had a positive impact on the operation of the GHO stablecoin, specifically reflected in:

1. Isolation Mode: GHO uses isolation mode to allow users to generate it using various assets supported by the Aave protocol, reducing the impact of market volatility on system stability.
2. Efficiency Mode: Efficiency mode allows users to borrow more GHO using non-volatile collateral assets to balance their positions, thereby increasing the supply of GHO in the market and alleviating demand pressure.
3. Cross-Chain Portals: The portal function provides an ideal way for GHO to expand in a multi-chain ecosystem, reducing the risk of cross-chain interactions.

Figure 12: GHO Mechanism

Lens Protocol is an innovative social network protocol launched by Aave on the Polygon blockchain. Its design concept is to serve as a modular underlying protocol aimed at promoting community expansion and continuous development. This protocol encourages developers to build various social applications on its foundation while ensuring that users have full control over their content and social relationships.

The core innovation of Lens Protocol lies in transforming social media behaviors into NFTs (Non-Fungible Tokens), mainly reflected in the following aspects:

1. Profile NFT: This serves as the user's identity proof in the Lens ecosystem. Users can obtain it by minting or purchasing. It contains the user's entire history of posts, mirrors, comments, etc., and grants the user full control over this content.
2. Collect NFT: This is the content monetization model for creators in the Lens ecosystem. Followers can purchase the content created by the creators.
3. Follow NFT: This is the follow model in the Lens ecosystem. When a user follows a profile on Lens Protocol, they receive a Follow NFT.

The functional modules of Lens Protocol include:

1. Publication: Divided into three types: posts, comments, and mirrors. Publications are directly posted to the user's Profile NFT, ensuring that all content created by the user belongs to the user.
2. Comment: Allows users to comment on other people's publications. Comments also exist in the user's NFT, thus fully belonging to the user.
3. Mirror: Equivalent to the retweet function in traditional social media. Since they reference other publications, they are subject to the conditions of the original publication's reference module and cannot be collected.

Currently, various social-related applications have been developed based on Lens Protocol, such as the decentralized Twitter alternative Lenster.xyz, the video content platform Lenstube.xyz, and the decentralized resume platform Orb.ac. These applications demonstrate the potential of Lens Protocol in reshaping social media interactions.

Figure 13: Lens Protocol Ecosystem Panorama

As the importance and influence of decentralized finance (DeFi) in the global financial market continue to grow, traditional fintech companies, hedge funds, family offices, and asset management companies have an increasing demand for DeFi solutions. In response to this market demand, Aave launched Aave Arc—a private liquidity pool solution designed specifically to meet the stringent regulatory requirements of institutional investors.

The private pools provided by Aave Arc are independent of the existing public liquidity pools on Aave, ensuring that participants can safely engage in the market in a regulatory-compliant environment.

In the Aave Arc ecosystem, USDC is the only stablecoin offered. The choice of USDC is due to its strict regulatory oversight, making it widely regarded as a suitable stablecoin for institutional investors. Besides USDC, Aave Arc also supports three other mainstream assets: Bitcoin (BTC), Ethereum (ETH), and AAVE.

To address institutional investors' concerns about regulatory risks, Aave Arc implements strict Know Your Customer (KYC) procedures and a "whitelist" mechanism, further enhancing the platform's security and compliance while providing higher trust and reliability for institutional users.

Figure 14: Aave Arc

According to Defillama data, Aave Arc TVL has remained at a low point since its sharp decline in November 2022, with no recent progress information.

Figure 15: Aave Arc TVL

According to Tokenterminal data, as of May 15, 2024, the cumulative borrowing fees generated by the Aave V3 protocol amounted to $146.6 million. Of this cumulative fee, borrowing fees on the Ethereum network accounted for the majority, reaching $45.6 million.

Figure 15: Aave Fees

Between 2023 and 2024, the annual total revenue of the Aave V2 and V3 protocols was $20.2646 million, a decrease of 3.2% compared to the $20.9262 million in the 2022 to 2023 period. Despite the slight decrease in revenue, since December 2022, the revenue of the Aave protocol has been sufficient to cover its token incentive expenditures, achieving a surplus, marking the robustness of Aave's financial management.

The main revenue of the Aave protocol can be divided into the following four categories:

Figure 16: Annual Revenue Analysis of Aave

• Borrowing Income (i.e., Protocol Revenue): Fees charged to borrowers when providing loans
• Flash Loan Fees: Fees charged to users utilizing the flash loan feature, with Aave V3 protocol charging 0.05% per flash loan transaction
• Other Functional Fees: Other fees acquired through liquidation, portal bridges, Aave Arc, etc.
• GHO Minting Fees

The lending industry plays a crucial role in the decentralized finance (DeFi) sector, ranking second in total value locked (TVL) among DeFi segments, just behind the liquid staking industry. According to data from defillama, there are currently 379 lending protocols in the market. Among these, top lending protocols include AAVE, JustLend, Spark, Compound, Venus, and Morpho.

Aave stands out in the DeFi sector with its significant leading position, currently holding a TVL of $1.025 billion. Among the top five lending protocols, Aave has successfully launched on 12 different blockchain networks, while the most among other protocols, Compound, has only launched on 4 chains.

Specifically, Aave (V2/V3) is the largest lending protocol on Ethereum, Arbitrum, Avalanche, Polygon, and Optimism, while it ranks fifth on BSC.

Figure 17: Comparison of DeFi Lending Tracks

Flash loans, as a key innovation in the DeFi ecosystem, have played a crucial role in the development of the entire decentralized financial system. According to Dune, the total transaction volume of flash loans in the past month reached approximately $248,596. Among the many flash loan tools, Balancer, Aave, and Uniswap are the top three, dominating the market.

From the perspective of market share, Balancer and Aave have performed particularly well in the past three months, with their market share roughly around 40%, higher than Uniswap.

Specifically, Aave's market share on Ethereum, Avalanche, Optimism, and Arbitrum is slightly lower than Balancer. However, on the Polygon network, Aave's market share significantly leads other flash loan tools, demonstrating its strong competitiveness and user base on this chain.

Figure 18: Comparison of Flash Loan Tracks

As mentioned earlier, Aave V3 introduced the Portals feature, and Aave V4 further designed the concept of a liquidity layer based on Portals, aiming to enhance cross-chain liquidity and asset utilization, which is an important innovation in the DeFi ecosystem. Similar products or features in the market include Radiant Capital, Cedro Finance, Flux V3, Prime Protocol, and Paribus. Although some cross-chain lending solutions have already emerged in the DeFi ecosystem, this field is still in the development stage overall.

Radiant Capital V2, by utilizing LayerZero's Omnichain technology, pioneered the construction of full-chain interoperability (although Radiant Capital temporarily suspended its lending market on Arbitrum in January 2024 due to security issues).

Overall, cross-chain lending is a gradually maturing and rapidly developing field. Radiant Capital, with its first-mover advantage, has a certain leading position in market maturity and user participation. Meanwhile, Aave, with its TVL far exceeding other competitors, shows great potential in the cross-chain lending field.

Figure 19: Comparison of Cross-Chain Lending Tracks

Since Aave launched its stablecoin GHO in July 2023, the price of GHO has long been below $1. In November 2023, Aave announced a series of measures to restore GHO's peg value, and these efforts were finally confirmed by Aave founder Stani Kulechov on February 7, 2024, announcing that GHO had successfully restored its peg.

Currently, GHO's market share in the non-fiat collateralized stablecoin market is about 0.504%. Compared to other more mature non-fiat collateralized stablecoins in the market, GHO, as an emerging stablecoin, has a relatively small market value, with its main use cases including staking on the Aave platform to earn yields or exchanging with other stablecoins for use.

Overall, GHO's development is still in its early stages, and Aave is taking various measures to enhance the stability of GHO's peg and has increased the minting cap to 50 million tokens. Through these initiatives, it can be observed that Aave is committed to deepening the integration of GHO with the Aave platform to promote its stablecoin's use in a broader range of applications.

Figure 20: Comparison of Stablecoin Tracks

The AAVE token, as the native governance token of the Aave platform, not only plays a core role in platform governance but is also a key component of the staking reward mechanism. The predecessor of the AAVE token was the LEND token issued by the ETHLend project in 2017. Initially, the total supply of LEND tokens was set at 1.3 billion.

As the Aave ecosystem continued to evolve, by 2020, Aave released its V1 version, accompanied by a rebranding, and LEND tokens were converted to AAVE tokens at a 1:100 exchange ratio. During this process, an additional 3 million AAVE tokens were issued to further support and promote the development of the Aave ecosystem. The total supply of AAVE tokens was thus set at 16 million.

According to the latest data from Coinmarketcap, the current circulating supply of AAVE tokens is approximately 14.7 million. This indicates that the circulating supply of AAVE tokens has occupied the vast majority of its total supply, reflecting the active participation of the Aave community and the importance of governance tokens in the DeFi ecosystem.

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Figure 21: AAVE Token Economics Illustration

Among the top ten Aave holding addresses, only the ninth is a whale, accounting for approximately 2.275%

Figure 22: AAVE Holding Analysis

In the Aave ecosystem, the AAVE token plays a crucial dual role: firstly, in the governance of the Aave protocol, and secondly, in staking within the safety module to earn protocol profit dividends.

Figure 23: AAVE Token Uses

The governance of the Aave protocol is operated and managed by holders of governance tokens AAVE, stkAAVE, and aAAVE in the form of a decentralized autonomous organization (DAO). Governance token holders receive governance weight based on the total balance of AAVE, stkAAVE, and aAAVE they hold, and are granted corresponding proposal and voting rights. In Aave Governance V3, each proposal designates a voting network, and all voting takes place on that network.

Figure 24: AAVE Governance Process

The Aave protocol offers AAVE token holders two staking options: pure AAVE staking and the Aave Balancer Pool Token (ABPT) staking pool, the latter consisting of 80% AAVE and 20% ETH.

Users can choose to stake AAVE tokens directly in Aave's safety module or provide liquidity for AAVE and ETH through the Balancer liquidity pool to obtain ABPT, which can then be staked in Aave's safety module. This method not only earns staking rewards but also offers the opportunity to receive additional BAL rewards and transaction fees.

Figure 25: Safety Module Mechanism

Aave's staking mechanism is an investment method that balances risk and reward. By staking AAVE tokens, users are willing to take on certain risks in exchange for safety incentive rewards. The safety module is designed to provide financial support in case the Aave protocol encounters financial issues. If funds are insufficient to cover losses, the protocol will initiate a "recovery issuance" mechanism to mint additional AAVE tokens to replenish funds.

The auction module of the Aave protocol uses a Dutch auction to manage the market issuance of staked funds. When necessary, funds are raised by auctioning AAVE and ETH to ensure market stability.

Users participating in staking will receive stkAAVE tokens, which are ERC-20 standard tokens that serve as proof of staking. Holders of stkAAVE can exercise voting rights and enjoy discounts when staking to obtain GHO.

Figure 26: Staking Mechanism

As of May 15, the Aave protocol on Ethereum showed strong TVL, reaching $10.252 billion. In the ranking of DeFi lending protocols, Aave is at the top, followed by Compound, Venus, and Radiant, with the total TVL of these four protocols amounting to $15.408 billion.

Figure 27: Aave V3 V2 TVL Comparison

Since the launch of Aave V3, the TVL (Total Value Locked) of Aave V2 has shown a gradual decline. After about six months of volatility, the TVL of Aave V3 entered a phase of stable growth and successfully surpassed the TVL of V2 in September 2023.

The overall market cap to TVL ratio (Mcap/TVL) of the Aave protocol has remained at a relatively low level, which is generally seen as a positive signal. A lower Mcap/TVL ratio indicates that the market cap of the protocol is relatively reasonable compared to the value locked on its platform, suggesting less market bubble and higher intrinsic value.

Figure 28: Lending Market User Comparison

Since 2021, the user base of the Aave platform has experienced two significant growth phases, mainly driven by the launch of Aave V3 and the market recovery at the end of 2023, along with the introduction of Aave's native stablecoin GHO. As of May 15, 2024, Aave V2 recorded 186 users, while Aave V3 had as many as 14,752 users, clearly indicating the popularity of the V3 version among users.

In the current Aave V3 user base, users providing liquidity and performing deposit and withdrawal operations occupy a large proportion, which may be related to the enhanced capital efficiency and diversified features of the V3 version. In contrast, among Aave V2 users, the proportion of users performing withdrawal operations and completing single transactions is higher, which may reflect the tendency of V2 users to use this version for one-time or simpler lending activities.

Figure 29: Lending Market Transaction Volume Comparison

In April 2024, Aave's transaction volume reached $26.588 billion, an increase of 16.9% compared to March, demonstrating that Aave not only has the highest transaction volume in the DeFi lending field but also the fastest recent growth rate. This significant growth trend reflects the high trust and preference of investors for the Aave platform during the market recovery period.

Figure 30: Comparison of Lending Market Utilization

Aave V3 significantly enhances asset utilization through its efficient mode (E-Mode), giving Aave V3 an overall advantage in asset utilization among similar DeFi lending protocols. Specifically, on the Radiant platform, WBTC and WETH have particularly high utilization rates. Aave V2 performs similarly to Radiant in terms of stablecoins, but Aave V3 clearly surpasses other protocols in utilization.

Currently, protocols like Radiant have already taken the lead in the cross-chain lending market. Although product stability in the cross-chain lending field still needs improvement, its potential market space is enormous. The launch speed of Aave V3 is relatively slower compared to its competitors, which may affect its competitiveness in this field.

Aave has consistently maintained a leading position in the lending market, but the competition is becoming increasingly fierce with many protocols offering innovative lending solutions, such as flash loans and cross-chain lending. These innovative initiatives may pose challenges to Aave's user growth and market share. Therefore, Aave needs to provide a unique value proposition to attract and retain users, maintaining its market leadership.

The stablecoin GHO within the Aave ecosystem has experienced slight de-pegging since its launch, although it has recently achieved preliminary stability. However, the integration of GHO with Aave's lending functions is not yet tight, and its role within the Aave ecosystem has not been fully realized.

As a leader in the decentralized finance (DeFi) lending sector, Aave significantly leads its competitors in asset utilization, market share, and transaction volume, playing a crucial role. However, Aave's leading position is not unshakeable. Protocols like Radiant and Compound have shown strong growth potential and have launched new versions with growth potential. To consolidate its market position, Aave can adopt the following strategies: strengthen its core lending business, promote the further development and full integration of GHO within Aave, establish the Aave Network designed in the V4 version, and expand its non-lending business ecosystem.