Aave V4: Strategic Upgrade of the Lending Giant and the Future Landscape of Decentralized Finance

As one of the cornerstones of the DeFi ecosystem, any movement from Aave, the largest and most mature lending protocol, receives significant attention from the industry. Recently, at the ETHCC conference, Aave's founder officially announced that the team is about to launch its next-generation major iteration version—Aave V4.

Aave V4 is not merely a simple routine upgrade, but a key milestone in Aave's long-term strategic roadmap for 2030. This upgrade was first proposed officially in May 2024, and its core goal is to systematically address the limitations exposed during the operation of the V3 version, particularly making breakthroughs in critical areas such as scalability and risk management. Through this far-reaching update, Aave aims to fundamentally reshape the underlying architecture and core functions of the DeFi lending protocol, preparing for the future development of the protocol.

In this article, we will explore in detail what Aave V4 includes. We will review its evolution, analyze its new architecture, and interpret these changes in the context of broader trends in the Decentralized Finance industry.

The Evolution of AAVE

The journey of AAVE began with ETHLend, a P2P platform where lenders and borrowers needed to find each other’s counterparties. However, the process of finding matching counterparties was slow and fraught with uncertainty. After deeply realizing these fundamental flaws, the team upgraded the brand from ETHLend to Aave (i.e., AAVE V1) in September 2018, decisively shifting from the P2P model to a Point-to-Contract (P2C) model based on liquidity pools, where funds were pooled together to enable instant lending. The subsequent Aave V2 further reduced transaction costs on the congested Ethereum network by optimizing smart contracts, thereby allowing more people to access Decentralized Finance.

The current version Aave V3 has made significant strides in capital efficiency and risk management compared to version V2. It introduces several key features, such as:

• Efficient Mode (E-Mode): When the prices of the assets deposited and borrowed by users are highly correlated (for example, between stablecoins or between ETH and stETH), E-Mode allows users to unlock higher borrowing capacity (such as higher LTV). This directly addresses the issue of insufficient capital efficiency of correlated assets in V2.

• Isolation Mode (Isolation Mode): Allows new, higher-risk assets to be launched in an "isolated" manner. The collateral provided in isolation mode can only be used to borrow a set of governance-approved stablecoins, with a clearly defined debt limit, and cannot be mixed with other collateral. This effectively "isolates" the risk of new assets, preventing risk contagion.

However, Aave V3 also exposes a deeper strategic limitation: a single entity structure cannot flexibly respond to the demands of emerging markets and diversified scenarios. Imagine a traditional bank that initially only accepts real estate as collateral. All its forms, processes, and risk assessment models are designed around real estate. Now, a customer wants to apply for a loan using their company's equity, patents, or even future receivables. The bank will find that its existing "one-size-fits-all" processes are completely unable to handle these new assets that have different risk characteristics. The bank must either undergo a painful internal reform or abandon these new businesses.

Aave V3 faces a similar dilemma. Its core smart contracts are tailored for crypto-native assets (such as ETH, WBTC, and stablecoins). When the industry began to introduce RWAs—such as tokenized government bonds or private credit—as collateral, the single architecture of Aave V3 proved to be inadequate. RWAs involve off-chain legal compliance, counterparty risk, and different liquidation logic, which cannot be simply integrated into the existing smart contract framework.

This is the core problem that Aave V4 aims to fundamentally address: how to evolve from a single rigid product into a flexible platform that can support countless financial scenarios.

AAVE V4: Modular New Architecture

Aave V4 introduces a brand new design called the "Liquidity Hub + Spoke" model. This architecture is a direct response to the limitations of the "single entity" approach, which can be understood through a simple analogy in traditional finance: a central bank and its network of commercial banks.

• Liquidity Hub: Aave's "Central Bank"

  • On each blockchain network running Aave, there will be a unified Liquidity Hub that aggregates all assets supplied by users. This hub serves as the central liquidity source for the entire network. It does not provide "retail" services directly to end users. Instead, it focuses on macro liquidity management and risk control, providing stable and deep liquidity for the entire ecosystem. This model is expected to improve capital utilization, bring higher returns to lenders, and offer lower interest rates to borrowers.

  • Liquidity centers on different chains are not isolated, but can efficiently communicate and transfer liquidity with each other. This is mainly achieved through a mechanism known as "Unified Cross-Chain Liquidity Layer" (CCLL), which is supported by the core technology of Chainlink's Cross-Chain Interoperability Protocol (CCIP).

• Spoke: Aave's "specialized commercial bank". The liquidity center operates in the background, allowing users to interact with the protocol through various Spokes. Spokes are user-facing, modular lending markets, each designed for a specific purpose and connected to the central liquidity center. They function like specialized commercial banks. For example, there might be:

  • Core Spoke: A general lending solution for handling blue-chip crypto assets with low risk and high liquidity, such as ETH and WBTC.

  • E-Mode Spoke: Specifically optimized for stablecoins, LST, and other highly correlated currency pairs, providing the highest capital efficiency.

  • RWA Spoke: Tailored for tokenized treasury bonds, real estate, and other real-world assets. This type of Spoke can integrate more stringent access, custody, or compliance rules to meet institutional and regulatory requirements.

  • A high-leverage trading Spoke designed for professional traders seeking high risk and high returns, featuring a special interest rate model and risk control parameters.

The most important aspect of this design is its openness. Aave V4 will allow developers to build and propose their own Spoke. If a new Spoke design passes Aave's governance approval, it can obtain a line of credit from the liquidity hub, thereby leveraging Aave's vast liquidity network to launch a new, specialized market. This fundamentally transforms Aave from a mere product into a foundational platform for financial innovation.

Comparison: AAVE VS. SKY (formerly MAKERDAO)

To fully understand Aave's strategic direction, it would be helpful to compare it with its main competitor Sky. Sky also adopts a modular architecture, which signifies that the entire industry is moving towards a more flexible and scalable design direction.

similar

The architecture of Sky can be described as "Sky Core + SubDAO".

• Sky Core plays the role of a "central bank" in the Sky ecosystem, inheriting the function of issuing stablecoins from MakerDAO (now USDS, originally DAI). It establishes the most fundamental rules (for example: which SubDAOs are approved to access the system, the total minting limit for each SubDAO, emergency shutdown mechanisms, etc.), maintains the stability of USDS, and serves as the ultimate credit and security guarantee.

• SubDAO is a semi-independent specialized organization operating within the Sky ecosystem, acting as a "commercial bank" for specific fields. The core work of SubDAO is asset management and risk assessment. They are authorized by the Sky Protocol to receive specific types of collateral and initiate a request to Sky Core for minting USDS. For example, Spark Protocol is currently the only mature SubDAO in the Sky ecosystem, focusing on lending and is a direct competitor to Aave. Other SubDAOs may focus on RWA assets or other niche markets.

The similarities between Aave's "Liquidity Hub + Spoke" and Sky's "Sky Core + SubDAO" are obvious: both recognize that a single entity cannot meet all market demands, and thus adopt the model of "central bank + specialized commercial banks": the central bank formulates policies and provides liquidity, while specialized commercial banks are responsible for developing specific business scenarios.

Looking back at the grievances between the AAVE and Sky projects, Sky Spark was born by directly forking the open-source code of Aave V3. The two sides also had intense disputes over the profit-sharing agreement, with Aave accusing Spark of failing to pay the promised 10% profit share. Now AAVE V4 has merely "borrowed" the mature modular design ideas from Sky, which can be seen as "using their own methods against them."

different

Despite their similarities, AAVE and Sky also have significant differences in core business, economic models, and ecological sovereignty.

First, let's talk about the types of liquidity: Aave's Liquidity Hub aims to provide liquidity for a wide range of asset classes, including stablecoins, volatile assets (such as ETH), and derivative assets (LSTs), among others. Sky, inheriting the genes of MakerDAO, has always centered its core strategy around the issuance, stability, and promotion of its native stablecoin USDS (formerly known as DAI). The main task of its SubDAO is to create more application scenarios and demand for USDS, deepening its liquidity moat.

Secondly, there is the economic model and sovereignty: this is the most fundamental difference between the two. The Sky SubDAO is granted a high degree of economic sovereignty, with each SubDAO allowed to issue its own governance tokens (for example, Spark's SPK token), which enables them to build independent economic models, implement their own incentive programs, and directly capture the value created by their business growth. This economic independence allows SubDAOs to evolve complex and powerful functional architectures. Taking Spark, the only mature example in the current Sky ecosystem, as an example, its operating model can be compared to a dual-layer financial system:

1. At the "commercial bank" level ( retail end ): It has a lending platform for end users called Spark Lend. This part of the business directly serves individual users, functioning similarly to the commercial banks we are familiar with.

2. At the "Regional Reserve Bank" level ( wholesale end ): Spark also has a liquidity layer called Spark Liquidity Layer (SLL), which acts as a regional "liquidity hub". After obtaining liquidity (such as USDC/USDS) from Sky Core, SLL not only provides funding support for its own "commercial bank" Spark Lend, but also "wholesales" this liquidity to other DeFi protocols, such as Morpho, and even competitors like Aave.

Therefore, Spark is not just a simple lending application, but a liquidity engine that integrates retail and wholesale operations, fully leveraging its SubDAO identity to create and distribute value within and outside the Sky ecosystem.

In contrast, the independence and autonomy of Spokes in Aave V4 are much weaker. Currently, Spokes cannot issue their own tokens. They are an extension of the Aave core protocol, and the value they generate (such as interest income) will flow back to the Aave DAO. Spokes are similar to different departments under a large group, operating under a unified Aave brand and economic framework, with the value created also returning to the group headquarters.

Macroscopic Perspective

The structural changes of Aave and Sky are not isolated events, but rather a direct response to the major trends shaping the future of Decentralized Finance.

Integrate RWA

The next frontier of DeFi growth is widely considered to be the tokenization of real-world assets such as government bonds, real estate, and private credit. These assets come with unique legal and compliance requirements, making them difficult to manage within a single, large protocol. Aave V4 and Sky's modular architecture are well-suited for this, allowing protocols to create independent, customizable, and even permissioned "sandbox" environments (such as RWA Spoke or RWA SubDAO) specifically designed to accommodate and manage RWA while maintaining their core decentralized and permissionless characteristics.

The Rise of Application Chains

One logical endpoint of this modular evolution is for major protocols to launch their own dedicated blockchains, known as "Appchain." Both Aave and Sky have announced plans to develop in this direction, separating