From ETHLend to Aave V4: The Complete Evolution of Decentralization in Lending

Aave is a multi-chain lending protocol that focuses on enabling peer-to-peer contract lending of crypto assets through a dynamic interest rate model and liquidity pools. Currently, it ranks third in total value locked among DeFi projects, particularly holding a leading position in the lending category. Aave's parent company, Avara, is gradually expanding its business into new areas, including cross-chain lending, stablecoins, open social protocols, and institutional lending platforms.

The total supply of AAVE tokens is 16 million, of which 13 million are allocated to token holders, and the remaining 3 million are injected into the reserves of the Aave ecosystem. Currently, the total amount of AAVE tokens in circulation on the market is approximately 14.8 million.

With the continuous expansion and maturation of Aave's business, both the TVL and price of AAVE have increased against the backdrop of a market recovery in 2024. Avara announced the upgrade plan for Aave V4 in May, focusing on further enhancing Aave's liquidity and asset utilization.

The Aave V3 version has basically replaced the V2 version, and the gradual stabilization of its business model and user base has led Aave to far surpass other lending protocols in terms of TVL, trading volume, and the number of supported chains.

Avara has encountered some challenges in expanding its business. Currently, its main revenue still relies on traditional lending services. The stablecoin GHO has recently restored its peg after experiencing a period of decoupling. The TVL of the institutional lending platform Aave Arc has remained at a low level after a significant drop.

For the future development of Aave, it is recommended to further optimize its cross-chain lending solutions, strengthen its stablecoin business and deeply integrate it with the Aave platform, incorporate Aave's DeFi capabilities into emerging businesses such as social platforms, and consolidate the currently relatively independent business segments into a comprehensive ecosystem.

The Development History of Aave

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

In November 2023, Aave Companies announced a rebranding to Avara. Avara is gradually launching new businesses, including the stablecoin GHO, the social network protocol Lens, and the institutional lending platform Aave Arc, and has begun strategic deployments in various fields such as cryptocurrency wallets and gaming.

The current version of Aave V3 has been stably put into use, and its services have expanded to 12 different blockchains. Meanwhile, Aave Labs is further attempting to upgrade the lending platform, announcing the upgrade proposal for version V4 in May 2024.

According to data provided by Defillama, as of May 15, 2024, AAVE ranks third in the DeFi space in terms of total locked value, reaching $1.0694 billion.

Core Team of Aave

Avara is headquartered in London, UK, initially made up of an innovative team of 18 people, and currently LinkedIn shows a total of 96 employees.

• Founder and CEO: Stani Kulechov holds a Master's degree in Law from the University of Helsinki, with his thesis focused on utilizing technology to enhance the efficiency of commercial agreements. He is also a Web 3 practitioner with a history of continuous entrepreneurial experience.
• Chief Operating Officer: Jordan Lazaro Gustave was exposed to coding in his teens and obtained a master's degree in Risk Management from University Paris X Nanterre.
• Chief Financial Officer: Peter Kerr graduated from Massey University and the University of Oxford, and has worked at several well-known banks before joining Avara as CFO in 2021.
• Institutional Business Head: Ajit Tripathi graduated from IMD Business School and the Indian Institute of Technology, and has worked for several well-known blockchain companies.

Aave's Financing Journey

• In 2017, ETHLend raised $16.2 million through an ICO, during which 1 billion units of LEND tokens were sold.
• In 2018, the project brand was upgraded to Aave.
• In July 2020, Aave secured a $3 million Series A investment 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 and will receive $200 million worth of Matic lending mining rewards provided by Polygon within a year.

Core Products and Features of Aave

Since its debut in January 2020, Aave has established its significant position in the decentralized finance space with core features such as its lending pools, aToken model, innovative interest rate mechanisms, and flash loan functionality. As Aave has evolved from V1 to V3, its lending business model has demonstrated a consistently robust development trend.

In December 2020, Aave released version V2, which significantly enhanced user experience by simplifying and optimizing its architecture, and introducing features such as debt tokenization and Flash Loans V2. According to the official white paper, the architectural optimization of V2 is expected to reduce Gas fees by about 15% to 20%. In January 2023, Aave launched version V3, which further improved the efficiency of capital utilization based on V2, with little overall change in architecture. Version V3 introduced three innovative features: Efficient Mode, Isolated Mode, and Portal.

In May 2024, Aave proposed the V4 version proposal, which plans to adopt a brand new architecture in the design of the new version, introduce a unified liquidity layer, obscure interest rate control, natively integrate GHO, and design Aave Network, among other features.

Borrowing Rate

Aave has designed specific interest rate strategy contracts for each type of reserve. Specifically, the following is defined in the basic strategy contract:

• Optimal Utilization Rate
• Base Variable Loan Interest Rate
• Variable Rate Slope 1
• Variable rate slope 2
• Stable interest rate slope 1
• Stable interest rate slope 2
• Basic Stable Lending Rate

The formula for variable interest rate calculation is:

Base variable borrowing rate + Utilization rate * Variable rate slope 1 + MAX(0, Utilization rate - Optimal utilization rate ) * Variable rate slope 2

By analyzing the interest rate model, we can find that when the current utilization rate is below the optimal utilization rate of the given market, the borrowing interest rate rises slowly. However, when the current utilization rate exceeds the optimal utilization rate, the lending rate sharply increases with the rise in utilization rate, that is: when liquidity is high in the trading pool, low rates encourage lending; when liquidity is low, high rates maintain liquidity.

Aave V3 has divided the interest rate model strategies into three types based on the risk status of different assets:

1. Mainstream assets: such as USDC, ETH, WBTC, etc., with an optimal utilization rate of 80%.
2. Medium risk assets: such as LINK, AAVE, etc., with an optimal utilization rate of 70%.
3. High-risk assets: such as UNI, YFI, the optimal utilization rate is 45%.

Lending Process and Liquidation Mechanism

In the interaction process of Aave, the lending and borrowing process is as follows:

• Depositors can obtain the corresponding aToken by depositing tokens into the Aave asset pool. These aTokens serve as proof of deposit, not only certifying the deposit activity but also allowing free trading and transfer in the secondary market.
• For borrowers, they can borrow cryptocurrency through over-collateralization or flash loans. When borrowers are ready to repay their debts, they not only need to return the principal but also pay interest calculated based on asset utilization rates and market supply and demand conditions. Once the debt is settled, borrowers can not only redeem their collateralized assets, but also the aToken linked to their collateralized assets will be correspondingly destroyed.

Aave's liquidation mechanism is as follows:

When the market value of the collateralized assets decreases or the value of the borrowed assets increases, causing the value of the borrower's collateral to fall below the established liquidation threshold, it triggers Aave's liquidation mechanism. Different tokens have different loan-to-value ratios and liquidation thresholds based on their risk characteristics. When liquidation occurs, the borrower must not only repay the principal and interest but also pay a certain percentage of the liquidation penalty to the third party executing the liquidation.

Related parameters:

• Loan-to-Value Ratio: Determines the maximum amount of assets a borrower can borrow. For example, a 70% LTV indicates that for collateral worth 100 USDT, the borrower can borrow a maximum of 70 USDT.
• Health Factor: Reflects the safety level of the loan position. The higher the health factor, the stronger the borrower's ability to repay; conversely, the lower the health factor, the weaker the ability to repay. Once the health factor falls below 1, it indicates that the collateral may face liquidation.
• Liquidation threshold: The minimum ratio between the value of the collateral assets and the value of the borrowed assets is set. When the borrower's position reaches this threshold, their collateral is at risk of being liquidated.

Flash Loan

In the Aave protocol, flash loans are a groundbreaking financial innovation that relies on the atomicity characteristic of Ethereum transactions: all operations in a transaction are either fully executed or not executed at all. This mechanism allows participants to borrow large amounts of assets without the need to provide collateral. Borrowers can borrow funds from Aave within the timeframe of a block (approximately 13 seconds) and repay within the same block, thus achieving a rapid closure of the lending process.

Flash loans greatly simplify the process of executing price arbitrage, automating trading strategies, and other Decentralization finance operations, while effectively avoiding liquidity risks. In the Aave V3 protocol, the transaction fee for each flash loan is 0.05%, which is significantly lower than Uniswap V2's 0.3%, providing users with a more economical borrowing option.

Credit Delegation Mechanism

Aave launched the credit delegation mechanism in August 2020. Through credit delegation, depositors can delegate their unused credit limits to other users, while borrowers can use this to gain additional borrowing capacity.

In addition, Opium launched credit default swap products in September 2020 targeting the credit delegation mechanism of Aave. CDS, as a risk management tool, allows investors to transfer the risk of default by specific borrowers, thereby adding an extra layer of protection to the credit delegation mechanism.

Main Upgrades of Aave V4

According to the proposal description for the Aave V4 protocol,