From ETHLend to Aave V4, the evolution of decentralized lending

Student author | @Elias201179

Instructor | @CryptoScott_ETH

Release time | 2024.5.21

• Aave is a multi-chain lending protocol, whose core business is to achieve P2C (peer-to-peer) lending of crypto assets through dynamic interest rate models and liquidity pools. Currently, its total locked value (TVL) ranks third among DeFi projects, especially in the lending category. Aave's parent company Avara is gradually expanding its business to 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 distributed to token holders, and the remaining 3 million are injected into the reserves of the Aave ecosystem. The total number of AAVE tokens currently in circulation is approximately 14.8 million.
• As Aave's business continues to expand and mature, AAVE's TVL and price will increase as the market recovers in 2024. Avara announced the upgrade plan for Aave V4 in May, focusing on further improving Aave's liquidity and asset utilization.
• Aave V3 has basically replaced V2. The gradual stabilization of its business model and user base has also made Aave far ahead of other lending protocols in terms of TVL, transaction volume, and number of supported chains.
• Avara has encountered some challenges in expanding its business. Currently, its main income still relies on traditional lending business. Stablecoin GHO has recently resumed its anchor after a period of de-anchoring. The TVL of institutional lending platform Aave Arc has been at a low level for a long time after a sharp drop.
• For the future development of Aave, suggestions include further optimizing its cross-chain lending solutions, strengthening its stablecoin business and deeply coupling it with the Aave platform, integrating Aave's DeFi capabilities in emerging businesses such as social platforms, and integrating the currently relatively independent business segments into a comprehensive ecosystem.

In the first quarter of 2024, the DeFi market showed significant growth and vitality, with fees and revenue reaching annual highs. The DeFi market collected more than $1.6 billion in fees and more than $467 million in total revenue last quarter, with monthly revenue reaching $230 million in March, a record high for the year.

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

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

In addition, Aave's lending revenue also increased by 40% to $34.9 million this quarter, continuing to lead the DeFi lending market. Despite facing fierce competition from competitors, Aave still dominates in terms of total locked value (TVL) and revenue.

Studying Aave’s performance in the DeFi market is also of great significance for understanding the development trend and future potential of the entire DeFi market. Aave’s success story and operating model can also serve as a reference and inspiration for other DeFi projects.

In May 2017, Stani Kulechov founded the ETHLend project. Initially, ETHLend encountered serious liquidity challenges during its operation. By the end of 2018, ETHLend had a strategic transformation, changing from a P2P (peer-to-peer) model to a P2C (peer-to-contract) model, introducing a liquidity pool model, and officially changed its name to Aave. This transformation marks the official launch of Aave in 2020.

In November 2023, Aave Companies announced a brand change to Avara. Avara has gradually launched new businesses including the stablecoin GHO, the social network protocol Lens, and the institutional lending platform Aave Arc, and has begun to make strategic layouts in multiple fields such as crypto wallets and games.

Currently, Aave V3 has been put into use stably, and its services have been expanded to 12 different blockchains. At the same time, Aave Labs further attempted to upgrade the lending platform and announced the V4 upgrade proposal in May 2024.

According to data provided by Deflama, as of May 15, 2024, AAVE ranked third in the total locked value (TVL) in the DeFi (decentralized finance) field, reaching US$1.0694 billion.

Aave's parent company Avara is headquartered in London, UK. It initially consisted of an 18-person innovation team, and currently LinkedIn shows that it has a total of 96 employees.

• Founder and CEO: Stani Kulechov received his Master of Laws from the University of Helsinki. His master's thesis was on using technology to improve the efficiency of business agreements. He is also a Web 3 practitioner with serial entrepreneurial experience.
• Chief Operating Officer (COO): Jordan Lazaro Gustave has been learning code since he was a teenager and obtained a master's degree in risk management at University Paris X Nanterre.
• Chief Financial Officer (CFO): Peter Kerr graduated from Massey University and University of Oxford. He has worked for HSBC, Deutsche Bank, Sonali Bank, etc. He joined Avara as CFO in 2021.
• Head of Institutional Business: Ajit Tripathi graduated from IMD Business School and Indian Institute of Technology, and has worked 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 brand was upgraded to Aave.
• In July 2020, Aave received a US$3 million Series A investment led by Three Arrows Capital.
• In October 2020, Aave received $25 million in Series B investment 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 from Polygon within one year.

 Figure 1: Aave historical events

Major events and announcements tend to have a significant impact on the price and total locked value (TVL) of decentralized lending protocols. For example, after the launch of Aave V2 at the end of 2020, both AAVE's price and TVL saw a significant increase. This trend continued during the DeFi Summer of 2021, when the collateral and lending scale of lending protocols continued to expand, maintaining Aave's high price levels. In March 2022, the launch of Aave V3 once again drove significant growth in AAVE's price and TVL. However, the subsequent UST decoupling event and the ensuing bear market led to an overall shrinkage of AAVE's TVL and a drop in price.

Although on November 5, 2023, Aave received a report on the functional problems of the Aave protocol and temporarily suspended the Aave V2 market transaction, which led to a short-term decline in AAVE price and TVL. However, as the overall market improves and GHO gradually resumes its anchoring, AAVE's price and TVL have shown a clear upward trend in the near future.

 Figure 2: Aave Price & Historical Events Chart 

 Figure 3: Aave TVL & Historical Events Chart 

Since its debut in January 2020, Aave has established its important position in the field of decentralized finance (DeFi) with its core features such as lending pools, aToken model, innovative interest rate mechanism, and flash loan function. As Aave evolves from V1 to V3, its lending business model has shown a sustained and stable development trend.

In December 2020, Aave released V2, which significantly improved the user experience by simplifying and optimizing its architecture and introducing features such as debt tokenization and flash loan V2. According to the official white paper, V2's architectural optimization is expected to reduce Gas fees by about 15% to 20%. In January 2023, Aave launched V3, which further enhanced the efficiency of capital utilization based on V2, and the overall architecture did not change much. V3 introduces three innovative features: E-mode, Isolation Mode, and Portal.

In May 2024, Aave proposed the V4 version proposal. In the design of the new version, it plans to adopt a brand-new architecture and introduce a unified liquidity layer, fuzzy control interest rates, GHO native integration, Aave Network and other designs. The specific details of the relevant mechanisms of the V4 version will be elaborated in the subsequent Section 4.1.6.

Figure 4: Aave Protocol V2 and V3 Architecture Changes

Borrowing rate

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

The variable interest rate calculation formula is:

By analyzing the interest rate model, we can find that when the current utilization rate is lower than the optimal utilization rate of a given market, the borrowing rate rises slowly. However, when the current utilization rate exceeds the optimal utilization rate, the borrowing rate rises sharply as the utilization rate increases, that is, when the liquidity in the trading pool is high, low interest rates encourage lending; when liquidity is low, high interest rates are used to maintain liquidity.

 Figure 5: Aave deposit rate change chart

Each asset has a predetermined optimal utilization rate. Based on the above interest rate model, Aave V3 divides three interest rate model strategies according to the risk status of different assets:

 Figure 6: Comparison of three interest rate model strategies of Aave V3 

In Aave’s interactive process, the lending process is as follows:

• Depositors can obtain corresponding aTokens by depositing tokens into Aave's asset pool. These aTokens, as deposit certificates, not only prove the deposit behavior, but can also be freely traded and transferred in the secondary market.
• For borrowers, they can borrow cryptocurrencies through overcollateralization or flash loan. When the borrower is ready to repay the debt, in addition to returning the principal, they must also pay interest calculated based on asset utilization and market supply and demand conditions. Once the debt is settled, the borrower can not only redeem their collateralized assets, but the aTokens linked to their collateralized assets will also be destroyed accordingly.

Aave’s liquidation mechanism is as follows:

When the market value of the mortgaged asset decreases or the value of the borrowed asset increases, causing the value of the borrower's collateral to fall below the established liquidation threshold, Aave's liquidation mechanism will be triggered. Different tokens have different loan-to-value ratios (LTV) and liquidation thresholds based on their risk characteristics. When liquidation occurs, in addition to paying the principal and interest, the borrower must also pay a certain percentage of the liquidation penalty (Liquidation Bonus) to the third party that executes the liquidation.

Related parameters:

• Loan-to-Value Ratio (LTV): Determines the maximum amount of assets that a borrower can lend. For example, a 70% LTV means that for a collateral value of 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 debt repayment ability; conversely, the lower the health factor, the weaker the debt repayment ability. Once the health factor drops below 1, it indicates that the collateral may face liquidation.

• Liquidation threshold: sets the minimum ratio between the value of the collateral asset and the value of the borrowed asset. When the borrower's position reaches this threshold, their collateral is at risk of being liquidated.

In the Aave protocol, Flash Loan are a groundbreaking financial innovation that relies on the atomicity of Ethereum transactions: all operations in a transaction are either fully executed or not executed at all. This mechanism enables participants to borrow large amounts of assets without providing collateral. Borrowers borrow funds from Aave within a block time frame (approximately 13 seconds) and repay them within the same block, thus achieving a fast closed loop in the lending process.

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

 Figure 7: Credit delegation mechanism diagram

Aave launched the Credit Delegation mechanism in August 2020. Through credit delegation, depositors can delegate their unused credit lines to other users, and borrowers can use this to obtain additional borrowing capacity.

In addition, Opium launched a credit default swap (CDS) product for Aave's credit delegation mechanism in September 2020. CDS, as a risk management tool, allows investors to transfer the risk of default of a specific borrower, thereby adding an extra layer of protection to the credit delegation mechanism. The following example explains how the credit delegation mechanism works and its implementation details through the case provided by Aave:

 Figure 8: Aave credit delegation example

1. As a depositor, Karen deposited $1 million USDT into Aave. According to Aave's settings, her annualized rate of return (APY) was 5%. As a deposit certificate, Karen received $1 million worth of aUSDT.
2. In order to further participate in the credit delegation mechanism, Karen needs to create a CDV (Credit Delegation Vault) smart contract. This contract will allow Karen to deposit $1 million worth of aUSDT and set various parameters including the credit limit. To do this, Karen needs to pay a 3% ETH stability fee.
3. Based on the parameters she set, Karen and Chad reached consensus on the loan terms through the OpenLaw platform and agreed to a loan at an annualized interest rate (APR) of 8%. Both parties agreed to the agreement and formally signed it.
4. Karen then added Chad's payment address to CDV's whitelist, allowing Chad to borrow $750,000 worth of ETH from CDV based on the credit line without providing any collateral assets.
5. In this case, Karen's actual annualized rate of return (APY) is calculated as the original 5% minus the 3% stability fee plus the 8% lending rate, that is, 5% - 3% + 8% = 10%. This rate of return is higher than the interest rate she would have received if she had deposited directly through Aave. Chad successfully borrowed $750,000 worth of ETH without collateral and agreed to pay an annualized interest rate of 8%.

According to the Aave V4 protocol development proposal, Aave V4 will be built with a brand-new architecture, adopting an efficient and modular design, while 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 on top of the Portal concept of Aave V3. Taking Aave as a whole as an example, the current Aave V2 and Aave V3 have dispersed liquidity due to version updates, and it took a long time for the overall liquidity to complete the migration from V2 to V3. The liquidity layer proposed by V4 aims to uniformly manage the upper limits, interest rates, assets, and incentives for supply and lending, allowing other modules to extract liquidity from it. In short, when Aave DAO plans to add or remove new functional modules (such as isolated pools, RWA modules, and CDPs) in the future, there is no need to migrate liquidity, and various modules only need to uniformly extract liquidity from the liquidity layer.

 Figure 9: Unified Liquidity Layer

• Liquidity Premium

Aave V4 introduces a liquidity premium feature, which is a function that adjusts the borrowing rate based on the risk profile of the collateral. A risk factor is assigned to each asset and dynamically adjusted based on market and external risk factors. Assets with lower risks (such as Ethereum) will enjoy lower borrowing rates, while assets with higher risks (such as Altcoin) will have relatively higher borrowing costs.

 Figure 10: Liquidity premium diagram

Fuzzy Control Interest Rate

Currently, Aave's interest rate setting not only increases the complexity of governance, but also affects capital efficiency. The Aave V4 proposal introduces a fully automatic interest rate mechanism that uses fuzzy interest rates to dynamically adjust the slope and inflection point of the interest rate curve. This innovative interest rate management method will allow Aave to flexibly increase or decrease the base interest rate based on real-time market demand, thereby providing depositors and borrowers with more optimized interest rates.

 Figure 11: Schematic diagram of fuzzy control interest rate

Aave V4 lending module

Aave V4 introduces a series of innovative features to improve lending security and user experience and simplify governance processes:

• The design of smart accounts and vaults has greatly improved the 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 when the borrowing is active or a liquidation event occurs, which increases the convenience and security of user interaction.
• V4 also proposes dynamic risk configuration to adjust risk parameters when market conditions change. Users are associated with the current configuration of assets when borrowing, and new asset configurations are provided to new users, avoiding affecting existing borrowers. In addition, V4 introduces an automatic delisting mechanism to simplify the asset delisting process.

Excess Debt Protection Mechanism

Since there is a risk of bad debt spreading in shared liquidity, Aave V4 introduces a new mechanism to track insolvent positions and automatically handle their accumulated excess debt. This mechanism sets a debt threshold, and once the threshold is exceeded, the corresponding asset will automatically lose its borrowing ability to prevent its bad debt from spreading, thereby protecting the shared liquidity model from contagion.

GHO native integration solution

Aave V4 proposes plans to strengthen integration with GHO, aiming to improve user experience and increase returns for stablecoin providers.

1. Native GHO minting: V4 proposes to efficiently perform native GHO minting in the liquidity layer;
2. GHO “soft” liquidation: Drawing on the liquidation model of crvUSD, V4 introduces a Lending-Liquidation Automated Market Maker (LLAMM) to simplify the liquidation process. Users can choose to convert to GHO when the market is down, or repurchase collateral when the market is up;
3. Stablecoin interest paid in GHO: V4 will support depositors to receive interest payments in GHO. When stablecoin depositors choose this option, interest payments will be converted to V4's PCV (Protocol Controlled Value), and the interest payment process will also enhance the stability of GHO and improve capital efficiency.
4. Emergency Redemption Mechanism: V4 proposes an emergency redemption mechanism to deal with extreme depegging situations. When this mechanism is triggered, the collateral corresponding to the position with the lowest health will be redeemed as GHO and used to repay its debt.

Aave Network

At the same time, the Aave team also proposed the concept of Aave Network. The Aave team expects to develop an Aave network that can serve as the main hub for Aave and GHO. The network will be based on Aave V4, use GHO for payment, and be managed by community voting through Aave Governance V3, and inherit network security from Ethereum. At present, the concept is still in the design stage, and the Aave team said they will pay close attention to L1 and L2 related technologies and select corresponding implementation solutions.

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

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

• Facilitator: A protocol, entity or project that controls the minting and destruction mechanism of GHO. Aave is the first facilitator of GHO.
• Bucket: The upper limit of GHO holdings is determined by community governance through voting. This upper limit is to maintain the stability and liquidity of GHO prices.
• Discount mode: The lending rate will be adjusted based on the amount of stkAAVE held.

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

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

 Figure 12: GHO mechanism 

Lens Protocol is an innovative social networking protocol launched by Aave on the Polygon blockchain. It is designed as a modular underlying protocol to promote community expansion and continuous development. This protocol encourages developers to build various social applications on top of it while ensuring that users have full control over their content and social relationships.

The core innovation of Lens Protocol is to transform social media behaviors into NFTs (non-fungible tokens), which is mainly reflected in the following aspects:

1. Profile NFT: It is the user's identity proof in the Lens ecosystem, which can be obtained by casting or purchasing. It contains the history of all the user's posts, mirrors, comments, etc., and gives the user full control over these contents.
2. Collect NFT: This is the content profit model for creators in the Lens ecosystem, where followers can purchase content created by creators.
3. Follow NFT: This is the user’s follow mode in the Lens ecosystem. When a user follows a profile on the Lens Protocol, they will receive a Follow NFT.

The functional modules of Lens Protocol include:

1. Publication: There are three types: posts, comments, and reposts. Publications are published directly 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 and are therefore completely owned by the user.
3. Mirror: Equivalent to the forwarding function in traditional social media. Since they reference other publications, they are subject to the conditions of the reference module of the original publication and cannot be collected.

Currently, a variety of 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, etc. These applications reflect the potential of Lens Protocol in reshaping social media interactions.

 Figure 13: Lens Protocol Ecosystem Panorama 

As decentralized finance (DeFi) grows in importance and influence in global financial markets, the demand for DeFi solutions from traditional fintech companies, hedge funds, family offices, and asset managers continues to grow. In response to this market demand, Aave has launched Aave Arc, a private liquidity pool solution designed for institutional investors that meet strict regulatory requirements.

The private pool provided by Aave Arc is independent of the existing public liquidity pools on Aave, ensuring that participants can safely participate in the market in an environment that complies with regulatory standards.

In the Aave Arc ecosystem, USDC is the only stablecoin provided. The reason for its selection is that USDC is strictly regulated and widely regarded as a stablecoin suitable for institutional investors. In addition to USDC, Aave Arc also supports three other mainstream assets: Bitcoin (BTC), Ethereum (ETH) and AAVE.

To meet the concerns of institutional investors about regulatory risks, Aave Arc has implemented strict customer identification (KYC) procedures and a "whitelist" mechanism, which not only further enhances the security and compliance of the platform, but also provides institutional-level users with higher trust and reliability.

 Figure 14: Aave Arc

According to data from Deflama, Aave Arc TVL has continued to remain at a low point after the plunge in November 2022, and there has been no relevant progress information recently.

 Figure 15: Aave Arc TVL 

According to data from Tokenterminal, as of May 15, 2024, the Aave V3 protocol has accumulated borrowing fees (Fees) of up to $146.6 Millions. Of this accumulated fee, borrowing fees on the Ethereum network accounted for the vast majority, reaching $45.6 Millions.

 Figure 15: Aave Fees

Between 2023 and 2024, the total annual protocol revenue of Aave V2 and V3 was $20,264,600, down 3.2% from $20,926,200 in 2022 and 2023. Despite the slight decrease in revenue, since December 2022, the Aave protocol's revenue has been sufficient to cover its token incentive expenditures and achieve a surplus, which is a sign of Aave's robust financial management.

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

 Figure 16: Aave annual revenue analysis

• Borrowing income (i.e. agreement income): the fee collected when providing loans to borrowers
• Flash loan fee: A fee charged to users who use the flash loan function. The Aave V3 protocol charges 0.05% for each flash loan transaction.
• Other functional fees: Other fees Aave obtains through liquidation, portal bridge, Aave Arc, etc.
• GHO Minting Fee

The lending industry plays a pivotal role in the field of decentralized finance (DeFi), and its total value locked (TVL) ranks second among all DeFi sectors, second only to the Liquid Staking industry. According to data provided by defillama, there are currently 379 lending protocols in the market. Among these protocols, the top lending protocols include AAVE, JustLend, Spark, Compound, Venus, and Morpho.

Aave stands out in the DeFi field with its significant leading advantage, with its current TVL reaching $1.025 billion. Among the top five lending protocols, Aave has successfully landed on 12 different blockchain networks, while Compound, which has the most landing chains among other protocols, has only 4.

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

 Figure 17: Defi lending track comparison 

As a key innovation in the DeFi ecosystem, flash loan have played a vital role in the development of the entire decentralized financial system. According to Dune data, the total transaction volume of flash loan reached approximately US$248,596 in the past month. Among the many flash loan tools, Balancer, Aave, and Uniswap ranked in the top three, becoming the dominant force in the market.

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

Specifically on different blockchain networks, Aave's market share on Ethereum, Avalanche, Optimism, and Arbitrum is slightly lower than Balancer. However, on the Polygon network, Aave's market share is significantly ahead of other flash loan tools, showing its strong competitiveness and user base on the chain.

 Figure 18: Comparison of flash loan tracks 

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

Radiant Capital V2 was the first to build full-chain interoperability by leveraging LayerZero’s Omnichain technology (although Radiant Capital briefly suspended its lending market on Arbitrum in January 2024 due to security issues).

In general, cross-chain lending is a field that is gradually maturing and developing rapidly. Radiant Capital has a certain leading position in market maturity and user participation with its first-mover advantage. At the same time, Aave has shown great potential in the field of cross-chain lending with its TVL far exceeding other competitors.

 Figure 19: Comparison of cross-chain lending tracks 

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

At present, GHO accounts for about 0.504% of the non-currency-collateralized stablecoin market. Compared with other more mature non-currency-collateralized stablecoins in the market, GHO, as an emerging stablecoin, has a relatively small market value. Its main usage scenarios include staking on the Aave platform to obtain returns, or exchanging with other stablecoins for use.

Overall, the development of GHO is still in its early stages. Aave is taking various measures to enhance the stability of GHO anchoring and has increased the coin cap to 50 million. Through these measures, it can be observed that Aave is committed to deepening the integration of GHO with the Aave platform to promote the use of its stablecoin in a wider range of application scenarios.

 Figure 20: Comparison of stablecoin tracks 

As the native governance token of the Aave platform, the AAVE token not only plays a core role in platform governance, but is also a key component of the staking rewards mechanism. The predecessor of the AAVE token is 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 continues to evolve, in 2020, Aave released its V1 version, accompanied by a rebranding, and LEND tokens were converted to AAVE tokens at a 1:100 exchange ratio. In 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 therefore set at 16 million.

According to the latest data from Coinmarketcap, there are currently about 14.7 million AAVE tokens in circulation in the market. This shows that the circulation of AAVE tokens has accounted for 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.

 Figure 21: AAVE token economics diagram 

 Among the top ten Aave holding addresses, only the ninth one is a large holder, accounting for about 2.275

 Figure 22: AAVE holdings analysis 

In the Aave ecosystem, the AAVE token plays a crucial dual role: first, participating in the governance of the Aave protocol, and second, staking in the security module to obtain dividends from the protocol's profits.

 Figure 23: AAVE token usage 

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

 Figure 24: AAVE governance process 

The Aave protocol provides two staking methods for AAVE token holders: pure AAVE staking and Aave Balancer Pool Token (ABPT) staking pool, the latter of which consists of 80% AAVE and 20% ETH.

Users can choose to stake AAVE tokens directly in Aave's security module, or provide liquidity of AAVE and ETH through the Balancer liquidity pool to obtain ABPT and stake it in Aave's security module. This method can not only earn staking income, but also have the opportunity to obtain additional BAL rewards and transaction fees.

 Figure 25: Security module mechanism

Aave's staking mechanism is an investment method that balances risk and return. By staking AAVE tokens, users are willing to take certain risks in exchange for security incentive rewards. The security module is designed to provide financial support when the Aave protocol encounters financial problems. If the funds are not enough to cover the losses, the protocol will initiate a "resumption issuance" mechanism to replenish funds by issuing additional AAVE tokens.

The auction module of the Aave protocol uses a Dutch auction and is responsible for managing the market issuance of pledged funds. When necessary, funds are raised through the auction of AAVE and ETH to ensure market stability.

Users who participate in staking will receive stkAAVE tokens, an ERC-20 standard token, as proof of staking. Users holding 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 B. In the ranking of DeFi lending protocols, Aave topped the list, followed by Compound, Venus, and Radiant. The total TVL of these four protocols is $15.408 billion.

 Figure 27: Aave V3 & V2 TVL comparison

Since the launch of Aave V3, the TVL (total locked value) of Aave V2 has experienced a gradual downward trend. After about half a year of fluctuations, the TVL of Aave V3 entered a stable growth phase and successfully surpassed the TVL of V2 in September 2023.

The Aave Protocol’s overall market capitalization to TVL ratio (Mcap/TVL) has remained low, which is generally seen as a positive sign. A low Mcap/TVL ratio indicates that the market capitalization of the protocol is reasonable relative to the value locked in its platform, suggesting less market froth and higher intrinsic value.

 Figure 28: Comparison of lending market users

Since 2021, the user base of the Aave platform has experienced two rounds of significant growth, mainly due to the launch of Aave V3 and the positive impact of the market recovery and Aave's launch of its native stablecoin GHO at the end of 2023. As of May 15, 2024, Aave V2 recorded 186 users, while Aave V3 had as many as 14,752 users, which clearly shows the popularity of V3 among users.

Among the current Aave V3 user group, users who provide liquidity and perform deposit and withdrawal operations account for a large proportion, which may be related to the enhanced capital efficiency and diversified functions of the V3 version. In contrast, among Aave V2 users, the proportion of users who perform withdrawal operations and only complete single transactions is higher, which may reflect that V2 users tend to use this version for one-time or simpler lending activities.

 Figure 29: Comparison of lending market transaction volume

Aave's trading volume in April 2024 reached $26.588 B, a figure that increased by 16.9% from March, showing that Aave not only has the highest trading volume in the DeFi lending field, but also has the fastest growth rate in recent years. This significant growth trend reflects the high trust and preference of investors for the Aave platform during the market recovery.

 Figure 30: Comparison of loan market utilization

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

Currently, protocols such as Radiant have taken the lead in the cross-chain lending market. Although the product stability in the cross-chain lending field needs to be strengthened, its potential market space is huge. The launch speed of Aave V3 is slightly slower than that of its competitors, which may affect its competitiveness in this field.

Aave has maintained its leading position in the lending market, but competition is becoming increasingly fierce in the face of numerous protocols that provide innovative lending solutions, such as flash loan and cross-chain lending. These innovative initiatives may pose a challenge to Aave's user growth and market share. Therefore, Aave needs to provide a unique value proposition to attract and retain users and maintain its market leadership.

The stablecoin GHO in the Aave ecosystem has been experiencing a slight decoupling phenomenon since its launch, although it has recently achieved initial stability. However, GHO's integration with Aave's lending function is not yet tight, and its role in the Aave ecosystem has not yet been fully utilized.

As a leader in the decentralized finance (DeFi) lending space, Aave plays a key role, significantly ahead of its competitors in terms of asset utilization, market share, and trading volume. However, Aave's leading position is not unshakable. Protocols such as Radiant and Compound have demonstrated strong growth potential and 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 of GHO and fully integrate it with Aave, establish the Aave Network designed by the V4 version, and expand its non-lending business ecosystem.