Written by: Umbrella, Deep Tide TechFlow
Reprint: White55, Mars Finance
On the evening of the 25th, AAVE founder Stani's announcement of the upcoming launch of AAVE V4 quickly attracted widespread attention and discussion, while the recent controversy over the 7% token allocation proposal between AAVE and WLFI has also been a hot topic in the market.
In no time, the market's attention has gathered around AAVE, this veteran lending protocol.
Although the controversy between AAVE and WLFI has not yet reached a final conclusion, this "farce" seems to reveal a different picture—"The new coins flow, but AAVE remains strong."
With the emergence of more new coins, stimulated by the fixed on-chain demand for token lending, AAVE undoubtedly possesses good fundamentals and catalysts.
This V4 update may allow us to see its strong competitiveness in the DeFi field in the future, as well as the root cause of its continually rising business volume.
From lending protocol to DeFi infrastructure
When we discuss AAVE V4, we first need to understand a key question: why does the market have high expectations for this upgrade?
From ETHLend in 2017 to today's DeFi giant with a TVL of $38.6 billion, as a veteran protocol, each version update of AAVE has essentially been an optimization, capable of influencing on-chain asset liquidity and gameplay to varying degrees.
The version history of AAVE is essentially the evolution of DeFi lending.
At the beginning of 2020, when V1 was launched, the total locked value in DeFi was less than $1 billion. AAVE adopted liquidity pools instead of the P2P model, transforming lending from "waiting for matching" to "instant transactions." This change helped AAVE quickly gain market share.
V2 was launched at the end of 2020, with its core innovations being flash loans and debt tokenization. Flash loans gave rise to arbitrage and liquidation ecosystems, becoming an important source of income for the protocol. Debt tokenization allowed positions to be transferred, paving the way for subsequent yield aggregators. The V3 of 2022 focused on cross-chain interoperability, allowing more on-chain assets to enter AAVE and becoming a connector for multi-chain liquidity.
More importantly, AAVE has become the pricing benchmark. DeFi protocols refer to AAVE's supply and demand curve when designing interest rates. New projects also benchmark AAVE's parameters when choosing collateral rates.
However, despite being infrastructure, the limitations of V3's architecture are becoming increasingly apparent.
The biggest problem is liquidity fragmentation. Currently, AAVE has $60 billion in TVL on Ethereum, but only $4.4 billion on Arbitrum, and even less on Base. Each chain is an independent kingdom, and funds cannot flow efficiently. This not only reduces capital efficiency but also limits the development of smaller chains.
The second issue is the bottleneck of innovation. Any new feature needs to go through a complete governance process, from proposal to implementation, which often takes months. In the fast-evolving DeFi environment, this speed clearly cannot keep pace with market demand.
The third issue is the inability to meet customized demands. RWA projects require KYC, GameFi needs NFT collateral, and institutions require isolated pools. However, the unified architecture of V3 struggles to meet these differentiated demands. It is either all supported or all not supported, with no middle ground.
This is the core issue V4 aims to address: how to transform AAVE from a powerful yet rigid product into a flexible and open platform.
V4 Upgrade
According to publicly available information, the core improvement direction of V4 is to introduce a "Unified Liquidity Layer," employing a Hub-Spoke model to change existing technical designs and even business models.
Image source @Eli5DeFi
Hub-Spoke: Solving the want-both problem
In simple terms, the Hub aggregates all liquidity, while Spokes handle specific business. Users always interact through Spokes, and each Spoke can have its own rules and risk parameters.
What does this mean? It means that AAVE no longer needs to serve everyone with a single set of rules, but can allow different Spokes to serve different needs.
For example, Frax Finance can create a dedicated Spoke that only accepts frxETH and FRAX as collateral, setting more aggressive parameters; meanwhile, an "institutional Spoke" may only accept BTC and ETH, requiring KYC but offering lower interest rates.
Two Spokes share the same Hub's liquidity but are risk-isolated from each other.
The brilliance of this architecture lies in its resolution of the "want both" dilemma. It requires both deep liquidity and risk isolation; both unified management and flexible customization. In the past, these were contradictory in AAVE, but the Hub-Spoke model allows them to coexist.
Dynamic risk premium mechanism
In addition to the Hub-Spoke architecture, V4 also introduces a dynamic risk premium mechanism, revolutionizing the way lending rates are set.
Unlike the unified interest rate model of V3, V4 dynamically adjusts interest rates based on collateral quality and market liquidity. For example, high liquidity assets like WETH enjoy a base interest rate, while more volatile assets like LINK must pay an additional premium. This mechanism is automatically executed through smart contracts, enhancing the protocol's security and making borrowing costs fairer.
Smart account
The smart account feature of V4 makes user operations more efficient. In the past, users needed to switch wallets between different chains or markets, managing complex positions was time-consuming and labor-intensive. Now, smart accounts allow for managing multi-chain assets and lending strategies through a single wallet, reducing operational steps.
A user can adjust WETH collateral on Ethereum and borrow on Aptos within the same interface, without manual cross-chain transfers. This simplified experience enables both small users and professional traders to participate in DeFi more easily.
Cross-chain and RWA: Expanding the boundaries of DeFi
V4 achieves second-level cross-chain interaction through Chainlink CCIP, supporting non-EVM chains like Aptos, allowing more assets to seamlessly access AAVE. For example, a user can use assets on Polygon as collateral to borrow on Arbitrum, all completed in a single transaction. In addition, V4 integrates real-world assets (RWA), such as tokenized government bonds, opening new pathways for institutional funds to enter DeFi. This not only expands AAVE's asset coverage but also makes the lending market more inclusive.
Market response
Although this week AAVE experienced a crash along with the broader crypto market, its rebound today is clearly stronger than that of other top DeFi projects.
After experiencing a sharp decline in the crypto market this week, AAVE's trading volume reached $18.72 million in 24 hours, far exceeding Uni's $7.2 million and LDO's $3.65 million, reflecting investors' positive response to protocol innovations, while the increase in trading activity further enhances liquidity.
TVL is a more intuitive reflection of market recognition. Compared to early August, AAVE's TVL surged by 19% this month to nearly $70 billion, setting a historical high, currently ranking first in TVL on the ETH chain. This growth far exceeds the average level of the DeFi market, and the increase in TVL also validates the effectiveness of AAVE V4's multi-asset support strategy, perhaps indicating that institutional funds have quietly entered the market.
According to TokenLogic data, AAVE's net asset total has reached a new high of $132.7 million (excluding AAVE token holdings), growing approximately 130% over the past year.
In terms of on-chain data, as of August 24, AAVE's open contracts exceeded $430 million, setting a new high in six months.
In addition to intuitive data, AAVE's upgrade has also sparked widespread discussion in the community. The preliminary information released for V4 has gained significant support and recognition, especially in terms of capital utilization and composable DeFi, showcasing more possibilities and potential in the market.
Make DeFi great again
Based on the currently disclosed update content, it is very likely that AAVE's upgrade will lead the DeFi market to the next level. The highlights of modular architecture, cross-chain expansion, and RWA integration not only ignite market enthusiasm but also drive the rise of prices and TVL.
Its founder Stani seems to be confident about the impact of the V4 upgrade on the DeFi space.
Perhaps in the near future, AAVE will ride the "east wind" of liquidity brought by the upcoming crypto bull market, soaring to new heights and opening up infinite possibilities.
