Written by: Arthur_0x
Compiled by Nicky, Foresight News
Aave is currently the largest and most proven lending protocol
As the undisputed leader in the on-chain lending space, Aave has an extremely solid and difficult-to-shake moat. We believe that as a leader in one of the most important sectors in the cryptocurrency field, Aave is severely undervalued and has huge future growth potential, which the market has not yet fully recognized.
Aave was launched on the Ethereum mainnet in January 2020 and has been operating steadily for five years. During this time, it has become one of the most proven protocols in the decentralized finance (DeFi) and lending space. The best example of this achievement is that Aave is currently the largest lending protocol, with an active loan volume of $7.5 billion, five times that of the second largest protocol, Spark.
Data as of August 5, 2024
Aave's various indicators continue to grow and have surpassed the highs of the previous cycle
Aave is also one of the few DeFi protocols that has exceeded the 2021 bull market indicators. For example, Aave's quarterly revenue has exceeded the peak revenue during the heyday of the bull market in the fourth quarter of 2021. More significantly, even when the market entered a consolidation phase from November 2022 to October 2023, Aave's revenue growth momentum continued to increase, and continued to maintain a strong growth acceleration. Entering the first and second quarters of 2024, as the market gradually warmed up, Aave's growth momentum remained strong, with its quarter-on-quarter growth remaining between 50-60%.
Image source: Token Terminal
Year-to-date, Aave’s total locked value (TVL) has almost doubled, a growth that is due both to an increase in deposits and to rising prices of underlying collateral assets such as WBTC and ETH tokens. As a result, Aave’s TVL has recovered to 51% of its 2021 cycle peak, demonstrating its strong resilience compared to other top DeFi protocols.
Data as of August 5, 2024
Aave’s remarkable profitability demonstrates product-market fit
In the last cycle, Aave’s revenue peaked when multiple smart contract platforms such as Polygon, Avalanche, and Fantom spent a lot of token incentives to attract users and liquidity. This caused speculative capital and leverage to surge to unsustainable levels, supporting the revenue figures of most protocols at the time.
As of today, the main chain’s token incentives have dried up, and Aave’s own token incentives have dropped to a negligible amount.
Image source: Token Terminal
Aave's growth across all metrics over the past few months has been organic and sustainable, driven primarily by a resurgence in market speculation, which in turn has driven up active lending and borrowing rates.
In addition, Aave has also demonstrated its ability to strengthen its fundamentals even during periods of reduced speculative activity. For example, during the global risk asset market crash in early August this year, Aave's revenue continued to perform well, thanks to its successful collection of liquidation fees when loans were repaid. This fully demonstrates Aave's ability to withstand the impact of market fluctuations on different underlying collateral and chains.
Data as of August 5, 2024. Source: TokenLogic
Despite the strong fundamental recovery, Aave's market performance reached its lowest level in three years.
Despite a strong recovery across all metrics over the past few months, Aave’s price-to-sales (P/S) ratio remains low at 17x after falling to its lowest level in three years, well below the three-year median of 62x.
Image source: Coingecko, Token Terminal
Aave is ready to expand its dominance in decentralized lending
Aave's moat is mainly composed of the following four points:
Reliability of the protocol’s security management record: Most new lending protocols encounter security incidents within their first year of operation. Aave has been running smoothly so far without any major smart contract-level security incidents. The security record brought by the platform’s strong risk management is often the primary consideration for DeFi users when choosing a lending platform, especially for whale with large amounts of funds.
Two-sided network effect: DeFi lending is a typical two-sided market. Depositors and borrowers constitute the supply and demand sides of the market respectively. The growth of one side will stimulate the growth of the other side, making it increasingly difficult for later competitors to catch up. In addition, the more abundant the overall liquidity of the platform, the smoother the liquidity in and out of depositors and borrowers, thereby attracting more large-scale capital users, which in turn stimulate further growth of the platform's business.
Excellent DAO governance: Aave Protocol has fully implemented DAO-based governance. Compared with the centralized team management model, DAO-based governance provides more comprehensive information disclosure and deeper community discussions about important decisions. In addition, Aave's DAO community also includes a group of professional institutions with high governance levels, including risk management service providers, market makers, third-party development teams, and financial consulting teams. This diverse source of participants promotes more active governance participation.
Multi-chain ecosystem positioning: Aave is deployed on almost all major EVM L1/L2 chains, and its TVL (total locked value) is in a leading position on all deployed chains except the BNB chain. In the upcoming Aave V4 version, cross-chain liquidity will be connected, making the advantages of cross-chain liquidity more prominent. See the figure below for details:
Data as of August 5, 2024, source: DeFiLlama
Improving AAVE token economics to drive value accrual and eliminate slashing risk
The Aave Chan Initiative recently launched a proposal to reform the AAVE token economics, which would enhance the utility of the token by introducing a revenue sharing mechanism.
The first major shift is to eliminate the risk of AAVE being slashed when the safety module is mobilized.
Currently, stakers of AAVE (stkAAVE, $228 million locked) and AAVE/ETH Balancer LP tokens (stkABPT, $99 million locked) in the Security Module are at risk of having their tokens slashed to cover a shortfall event.
However, due to the lack of correlation between stkAAVE and stkABPT and collateral assets that have accumulated distressed debt, they are not good collateral assets. In such an event, selling pressure on AAVE will also cyclically reduce coverage.
Under the new Umbrella Safety Module, stkAAVE and stkABPT will be replaced by stk aTokens starting with aUSDC and awETH. Providers of aUSDC and awETH can choose to stake their assets to earn additional fees (in the form of AAVE, GHO, protocol revenue, etc.) on top of the interest paid by borrowers. These staked assets may be slashed and destroyed in the event of a shortage event.
This arrangement is beneficial for both platform users and AAVE token holders.
In addition, more demand drivers for AAVE will be introduced through a revenue sharing mechanism.
Introduction of Anti-GHO
Currently, stkAAVE users enjoy a 3% discount when minting and borrowing GHO.
This will be replaced by a new “anti-GHO” token generated by stkAAVE holders who mint GHO. The generation of Anti-GHO tokens is linear and proportional to the interest accumulated by all GHO borrowers.
Users can apply for Anti-GHO and use it in two ways:
Burn Anti-GHO to mint GHO, which can be used to repay debt for free.
Stored in stkGHO's GHO security module.
This increases alignment between AAVE stakers and GHO borrowers and will be the first step in a broader revenue sharing strategy.
Burning and distribution plan
Aave will allow redistribution of net excess protocol revenue to token stakers, subject to the following conditions:
Aave Collector Net Holdings is calculated based on the past 30 days recurring costs of 2-year service providers.
Aave Protocol’s 90-day annualized revenue represents 150% of all protocol spending YTD, including the AAVE acquisition budget as well as the aWETH and aUSDC Umbrella budgets.
We will begin to observe consistent buybacks of 8-figure amounts on the Aave Protocol, and this number is expected to increase further as the Aave Protocol continues to grow.
Additionally, AAVE is almost fully diluted with no significant future supply unlocking, in stark contrast to recent newly issued tokens that have experienced sharp price drops after token generation events (TGEs) due to low initial circulation and high fully diluted valuations (FDVs).
Aave will see significant growth in the future
Aave has multiple growth factors and is well-positioned to benefit from the long-term growth of cryptocurrencies as an asset class. Fundamentally, Aave’s revenue can grow in a number of ways:
Aave v4
Aave V4 aims to further enhance its functionality and put the protocol on track to attract the next billion users to the decentralized finance (DeFi) space. First, Aave will focus on revolutionizing the user interaction experience with DeFi by building a unified liquidity layer. By enabling seamless liquidity access across multiple networks (including EVM and eventually non-EVM networks), Aave will eliminate the complexity of cross-chain conversions in the lending process. The unified liquidity layer will also rely heavily on account abstraction and smart accounts to allow users to manage multiple positions across isolated assets.
Secondly, Aave will increase the accessibility of its platform by expanding to other chains and introducing new asset classes. In June of this year, the Aave community supported the deployment of the protocol on zkSync. The move marked Aave's entry into its 13th blockchain network. Then in July of this year, the Aptos Foundation put forward a proposal to recommend that Aave be deployed on Aptos. If passed, the deployment on Aptos will be Aave's first foray into non-EVM networks and further consolidate its position as a true multi-chain DeFi leader. In addition, Aave will also explore the integration of RWA-based products that will be built around GHO. This move has the potential to connect traditional finance with DeFi, attract institutional investors, and bring a lot of new capital to the Aave ecosystem.
These developments culminated in the creation of the Aave Network, which will serve as the central hub for stakeholders to interact with the protocol. GHO will be used as a fee payment tool, while AAVE will become the primary staking asset for decentralized stakers. Given that the Aave Network will be developed as either an L1 or L2 network, we expect the market to re-evaluate its token value accordingly to reflect the additional infrastructure layers being built.
Aave’s growth is positively correlated with the growth of BTC and ETH as an asset class
The launch of the Bitcoin Spot ETF and Ethereum Spot ETF this year is a watershed moment for the adoption of cryptocurrencies by traditional finance, providing investors with a regulated and familiar way to gain exposure to digital assets without the complexity of holding them directly. By lowering the barrier to entry, these ETFs are expected to attract a large amount of capital from both institutional and retail investors, further promoting the integration of digital assets into mainstream investment portfolios.
The growth of the broader cryptocurrency market is a boon for Aave, as over 75% of its asset base is made up of non-stable assets (primarily BTC and ETH derivatives). Therefore, Aave's total value locked (TVL) and revenue growth are directly correlated to the growth of these assets.
Aave’s growth is tied to stablecoin supply
We can also foresee Aave benefiting from the growth of the stablecoin market. As global central banks signal a shift to a rate cut cycle, this will reduce the opportunity cost for investors seeking sources of yield. This may drive capital from yield instruments in traditional finance (TradFi) to stablecoin staking in decentralized finance (DeFi) to obtain more attractive returns. In addition, during bull markets, we can foresee higher risk appetite behavior, which will help increase the utilization of stablecoin lending on platforms such as Aave.
Final Thoughts
To reiterate, we are optimistic about Aave’s leading position in the large and growing decentralized lending market. We further outline the key drivers supporting its future growth and detail how each of them can further expand.
Aave will continue to capture market share as it has built a strong network effect driven by the liquidity and composability of its tokens. Upcoming tokenomics upgrades are designed to further improve the security of the protocol and enhance its value capture capabilities.
Over the past few years, the market has lumped all decentralized finance (DeFi) protocols into one category and priced them as if they have limited future growth potential. This is evident in Aave's total value locked (TVL) and revenue growth rates rising while its valuation multiples are compressing. We believe this divergence between valuations and fundamentals will not last long, and that AAVE tokens now offer some of the best risk-adjusted investment opportunities in the crypto space.
