Written by: Umbrella, Deep Tide TechFlow
On the evening of the 25th, AAVE founder Stani's announcement of the upcoming AAVE V4 quickly attracted a lot of attention and discussion, while the recent controversy between AAVE and WLFI regarding the 7% token allocation proposal has also been making waves in the market.
For a time, the market's attention was focused on AAVE, this established lending protocol.
Although the controversy between AAVE and WLFI has not yet reached a final conclusion, behind this 'farce,' it seems to present a different picture — 'the flowing new coins, the solid AAVE.'
With the emergence of more new coins and the stimulation of fixed on-chain token lending demand, AAVE undoubtedly has good fundamentals and catalysts.
This V4 update may help us see its strong competitiveness in the DeFi field in the future, as well as the roots of its continuously 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 expectations for this upgrade?
From ETHLend in 2017 to today's DeFi giant with $38.6 billion in TVL, as an established protocol, each version update of AAVE has been optimizing and can impact the liquidity and gameplay of on-chain assets to varying degrees.
The version history of AAVE is, in fact, 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 P2P models, 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 core innovations being flash loans and debt tokenization. Flash loans gave rise to the arbitrage and liquidation ecosystem, becoming an important source of income for the protocol. Debt tokenization allowed positions to be transferred, paving the way for subsequent yield aggregators. V3 in 2022 focused on cross-chain interoperability, allowing more on-chain assets to enter AAVE, becoming a connector of multi-chain liquidity.
More importantly, AAVE has become a pricing benchmark. DeFi protocols refer to AAVE's supply and demand curve when designing interest rates. New projects also benchmark AAVE's parameters when selecting collateral rates.
However, despite being an infrastructure, the architectural limitations of V3 are becoming increasingly apparent.
The biggest problem is liquidity fragmentation. Currently, AAVE has $60 billion in TVL on Ethereum, 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 innovation bottleneck. Any new feature needs to go through a complete governance process, from proposal to implementation often takes months. In the fast-evolving DeFi environment, this speed clearly cannot keep up with market demands.
The third issue is that customization needs cannot be met. RWA projects require KYC, GameFi requires NFT collateral, and institutions need isolated pools. However, V3's unified architecture struggles to accommodate these differentiated needs. It either fully supports them or does not support them at all, with no middle ground.
This is the core issue that V4 aims to solve: how to transform AAVE from a powerful but rigid product into a flexible and open platform.
V4 Upgrade
According to publicly available information, the core improvement direction of V4 lies in introducing a 'Unified Liquidity Layer,' adopting a Hub-Spoke model to change existing technical designs or even business models.
Image source @Eli5DeFi
Hub-Spoke: Solving the problem of wanting both
In simple terms, the Hub gathers all liquidity, and the Spoke is responsible for specific business. Users always interact through the Spoke, and each Spoke can have its own rules and risk parameters.
What does this mean? It means that AAVE no longer needs to use a single set of rules to serve everyone but can allow different Spokes to serve different needs.
For example, Frax Finance could create a dedicated Spoke that only accepts frxETH and FRAX as collateral, setting more aggressive parameters; meanwhile, an 'institutional Spoke' might 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 ability to solve the dilemma of 'wanting both.' It needs both deep liquidity and risk isolation; it needs unified management while allowing 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, innovating 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 rate, while more volatile assets like LINK need to pay an additional premium. This mechanism is automated through smart contracts, enhancing the protocol's security and making borrowing costs fairer.
Smart accounts
The smart account feature of V4 allows users to operate more efficiently. In the past, users had to switch wallets between different chains or markets, managing complex positions was time-consuming and laborious. Now, smart accounts allow management of multi-chain assets and lending strategies through a single wallet, reducing operational steps.
A user can adjust WETH collateral on Ethereum and loans on Aptos within the same interface without manually transferring across chains. This simplified experience makes it easier for small users and professional traders to participate in DeFi.
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 connect to AAVE. For example, a user can use assets on Polygon as collateral to borrow on Arbitrum, all completed in a single transaction. Additionally, 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 AAVE experienced a market crash this week alongside the broader crypto market, its rebound today is significantly stronger than that of other leading DeFi assets.
The AAVE token experienced a trading volume of $18.72 million across the network within 24 hours after the recent market crash, far exceeding Uni's $7.2 million and Ldo's $3.65 million, reflecting investors' positive response to protocol innovation, while the increased trading activity further enhanced liquidity.
TVL more intuitively reflects the market's level of recognition. Compared to early August, AAVE's TVL surged 19% this month to nearly $70 billion, setting a new historical high, currently ranking first in TVL on the ETH chain. This growth far exceeds the average level in the DeFi market, and the increase in TVL also validates the effectiveness of AAVE V4's multi-asset support strategy, perhaps hinting that institutional funds have quietly entered the market.
According to TokenLogic data, AAVE's net assets have 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 extensive discussion within the community. The preliminary information released for V4 has received a lot of support and recognition, especially regarding capital utilization and composable DeFi, showing the market more possibilities and potential.
Make DeFi great again
Considering the already disclosed updates, AAVE's upgrade is likely to lead the DeFi market to a new level. Modular architecture, cross-chain expansion, and RWA integration are highlights of the upgrade that not only ignite market enthusiasm but also drive up prices and TVL.
Its founder Stani also seems confident about the impact of the V4 upgrade on the DeFi sector.
Perhaps in the near future, AAVE will ride the 'wind of liquidity' brought by the upcoming crypto bull market and soar, opening up infinite possibilities.
