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

Aave is a multi-chain lending protocol whose core business is to achieve peer-to-peer contract lending of crypto assets through a dynamic interest rate model and liquidity pools. Currently, its total locked value ranks third among DeFi projects, especially leading 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, while the remaining 3 million are injected into the reserves of the Aave ecosystem. Currently, the circulating supply of AAVE tokens in the market is approximately 14.8 million.

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

The Aave V3 version has essentially replaced the V2 version, and the gradual stabilization of its business model and user base has made Aave far ahead of 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 operations. The stablecoin GHO has recently regained its peg after experiencing a period of de-pegging. The TVL of the institutional lending platform Aave Arc has remained at a low level after a sharp decline.

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, integrate Aave's DeFi capabilities into emerging businesses such as social platforms, and consolidate the currently relatively independent business segments into a comprehensive ecosystem.

Aave Development History

In May 2017, Stani Kulechov founded the ETHLend project. Initially, ETHLend faced serious liquidity challenges during its operations. 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 layouts in multiple fields such as crypto 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 with a total locked value of $1.0694 billion.

Aave Core Team

Avara is headquartered in London, UK, originally consisting of an innovative team of 18 people, and now has a total of 96 employees.

• Founder and CEO: Stani Kulechov obtained a Master of Laws degree from the University of Helsinki, with his master's thesis focusing on using technology to improve the efficiency of business agreements. He is also a Web 3 practitioner with a track record of continuous entrepreneurship.
• Chief Operating Officer: Jordan Lazaro Gustave was introduced 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, has worked at several banks, and joined Avara as CFO in 2021.
• Head of Institutional Business: Ajit Tripathi graduated from IMD Business School and the Indian Institute of Technology, and has worked for several cryptocurrency-related companies.

Aave Financing Journey

• 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 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 Business Model of Aave Protocol

Since its debut in January 2020, Aave has established its important 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 launched version V2, which significantly enhanced the user experience by simplifying and optimizing its architecture, as well as 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 approximately 15% to 20%. In January 2023, Aave released version V3, which further improved the efficiency of fund utilization based on V2, with little change to the overall 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 control of interest rates, natively integrate GHO, and include designs such as the Aave Network.

Borrowing Rate

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

• Optimal Utilization Rate
• Base Rate
• Interest rate slope 1
• Interest rate slope 2
• Stable borrowing rate deviation
• Stable Loan Rate Max
• Reserve Factor

The formula for calculating variable interest rates is:

Interest Rate = Base Rate + Utilization Rate * Slope 1 (when Utilization Rate <= Optimal Utilization Rate) Interest rate = Base interest rate + Optimal utilization rate * Slope 1 + ( utilization rate - Optimal utilization rate ) * Slope 2 (when utilization rate > optimal utilization rate)

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 interest rate rises sharply with the increase in utilization rate. That is: when liquidity in the trading pool is high, low interest rates encourage lending; when liquidity is low, high interest rates maintain liquidity.

Aave V3 categorizes three interest rate model strategies based on the risk status of different assets.

Aave's lending process

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

• Depositors can obtain the corresponding aToken by depositing tokens into Aave's asset pool. These aTokens serve as proof of deposit, not only confirming the deposit activity but also allowing free trading and transfer in the secondary market.
• For borrowers, they can borrow cryptocurrencies through over-collateralization or flash loans. When borrowers are ready to repay their debts, they need to return not only 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 accordingly destroyed.

Aave's liquidation mechanism

When the market value of the collateralized assets decreases or the value of the borrowed assets increases, leading to the value of the borrower's collateral falling below the established liquidation threshold, Aave's liquidation mechanism will be triggered. Different tokens have different loan-to-value ratios and liquidation thresholds based on their risk characteristics. At the time of liquidation, the borrower must not only pay back the principal and interest but also pay a certain percentage of a liquidation penalty to the third party executing the liquidation.

Related parameters:

• Loan-to-Value Ratio (LTV): Determines the maximum amount of assets that a borrower can borrow. For example, an LTV of 70% means that for collateral worth 100 USDT, the borrower can borrow a maximum of 70 USDT.
• Health Factor: Reflects the security level of the borrowing 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 drops below 1, it indicates that the collateral may face liquidation.
• Liquidation Threshold: The minimum ratio between the value of collateral assets and 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 rely on the atomicity characteristic of Ethereum transactions: all operations within a transaction must either be fully executed or not executed at all. This mechanism allows participants to borrow large amounts of assets without the need for collateral. Borrowers can borrow funds from Aave within a block's timeframe (approximately 13 seconds) and complete repayment within the same block, thereby achieving a fast closed loop in the borrowing process.

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

Credit Delegation Mechanism

Aave launched its 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 a credit default swap product in September 2020 targeting Aave's credit delegation mechanism. 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.

Aave V4 Major Innovations

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

Liquidity Layer

• Unified Liquidity Layer

The liquidity layer is designed on top of the Portal concept in the Aave V3 version. Taking Aave as a whole, the current Aave V2 and Aave V3 have resulted in fragmented liquidity due to version updates, and the overall migration of liquidity 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 the future Aave