Original title: Aave, the Core Pillar of Decentralized Finance and Onchain Economy

Original author: Arthur, founder of DeFiance Capital

Original translation: Ismay, BlockBeats

Editor's note: This article takes an in-depth look at Aave's dominance in the decentralized lending market and its future growth prospects. With the launch of Bitcoin and Ethereum ETFs, Aave is expected to benefit from the continued growth of crypto assets as an emerging asset class. In addition, as the global market demand for stablecoins increases, Aave's revenue and TVL will continue to climb. This article also analyzes Aave's upcoming V4 version and its token economic model upgrade, which will further consolidate its market position and bring more attractive risk-adjusted returns to investors. Through a comprehensive analysis of Aave's current status and potential, this article shows readers the core competitiveness of this leading project and its growth potential in the future.

The following is the original text:

Aave is the largest and most battle-tested lending protocol currently in existence.

As the undisputed leader in on-chain lending, Aave has a very defensible and sticky moat. We believe that Aave is significantly undervalued as a leader in this important crypto industry and has huge growth potential ahead, which the market has not yet fully reflected.

Aave launched on the Ethereum mainnet in January 2020 and is now in its fifth year of operation. Since its launch, Aave has firmly established itself as one of the most reliable protocols in the DeFi and lending space. As a testament to this, Aave is currently the largest lending protocol with a total active loan amount of $7.5 billion, five times the size of the second largest protocol, Spark.

(data as of August 5, 2024)

Protocol metrics continue to grow and have surpassed the highs of the previous cycle

Aave is one of the few DeFi protocols that has surpassed the 2021 bull run metrics. For example, its quarterly revenue has exceeded the peak in Q4 2021. Notably, even when the market remained sideways between November 2022 and October 2023, Aave's revenue growth continued to accelerate quarter by quarter. When the market picks up in Q1 and Q2 2024, its growth rate continues to remain strong, increasing by 50-60% per quarter.

(Source: Token Terminal)

Aave’s TVL has nearly doubled YTD, driven by increased deposits and higher token prices for underlying collateral assets such as WBTC and ETH. As a result, TVL has recovered to 51% of its 2021 cycle peak, demonstrating its resilience compared to other top DeFi protocols.

Data as of August 5, 2024.

Excellent yield quality demonstrates product-market fit

Aave’s revenue peaked in the last cycle, when multiple smart contract platforms such as Polygon, Avalanche, and Fantom attracted users and liquidity through massive token incentives.

This led to an unsustainable influx of “hot money” and leverage, which pushed up the revenue figures of most protocols during that period.

However, today, the token incentives of major chains have basically dried up, and Aave’s own token incentives have also fallen to almost negligible levels.

（Source: Token Terminal）

This shows that the growth of indicators in the past few months is organic and sustainable, mainly driven by the rebound of market speculation, which has increased active lending and borrowing rates.

In addition, Aave has demonstrated its ability to grow its fundamentals even in periods of subdued speculative enthusiasm. During the widespread global crash in risky assets in early August, Aave’s revenue remained resilient as it successfully captured liquidation fees as loans were repaid. This also proves its ability to cope with market fluctuations on different collateral bases and chains.

(Data as of August 5, 2024 Source: TokenLogic)

Despite the strong recovery in fundamentals, Aave's P/E ratio is at its lowest level in three years

Despite the strong recovery of Aave's indicators in the past few months, its price-to-sales ratio (P/S) remains sluggish, currently at 17 times, which has fallen to the lowest level in three years and is well below the three-year median of 62 times.

（Source: Coingecko, Token Terminal）

Aave is expected to continue to consolidate its dominance in the field of decentralized lending

Aave's moat mainly consists of the following four aspects:

Good record of protocol security management:Most emerging lending protocols will encounter security incidents within the first year of operation, while Aave has not had any major smart contract-level security incidents so far. For DeFi users, especially large users with a lot of funds, a platform's security record brought by a sound risk management is usually the first consideration when choosing a lending platform.

Two-sided network effect:DeFi lending is a typical two-sided market, with depositors and borrowers constituting the supply and demand sides respectively. The growth of one side will stimulate the growth of the other side, making it increasingly difficult for latecomers 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, which makes the platform more attractive to large capital users, further promoting the growth of the platform business.

Excellent DAO Management:The Aave protocol has fully implemented DAO-based management. Compared with the centralized team management model, DAO management provides more comprehensive information disclosure and has more in-depth community discussions on important decisions. In addition, Aave's DAO community includes a group of professional institutions with high governance levels, including top risk management service providers, market makers, third-party development teams, and financial advisory teams. These diverse sources of participants have prompted active governance participation.

Multi-chain ecosystem positioning:Aave is deployed on almost all major EVM L1/L2 chains, and its TVL (total locked volume) is in a leading position on all deployed chains except 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)

The redesigned token economic model will drive value accumulation and eliminate slashing risks

The Aave Chan Initiative has just published a proposal to overhaul $AAVE’s token economics model, enhancing the utility of the token by introducing a revenue sharing mechanism.

The first major change is to remove the slashing risk that $AAVE faces when the Safety Module is activated.

Currently, $AAVE stakers (stkAAVE - $228M locked) and $AAVE/$ETH Balancer LP tokens held in the Safety Module (stkABPT - $99M locked) have their tokens potentially slashed to cover a shortfall event.

However, stkAAVE and stkABPT are not ideal covering assets due to their lack of correlation to the collateral assets that generate bad debts. In such an event, selling pressure on $AAVE would in turn reduce the covering capacity.

Under the new Umbrella security module, stkAAVE and stkABPT will be replaced with stkaTokens led by aUSDC and awETH. Suppliers of aUSDC and awETH can choose to stake their assets to earn additional fees (paid in $AAVE, $GHO, protocol revenue) on top of the interest paid by borrowers. These staked assets are subject to slashing and destruction in a shortage event.

· This arrangement is beneficial to both platform users and $AAVE token holders.

In addition, through the revenue sharing mechanism, more $AAVE demand drivers will be introduced.

·Introduction of Anti-GHO Mechanism:

Currently, stkAAVE users enjoy a 3% discount when minting and borrowing $GHO.

This will be replaced by a new "anti-GHO" token, which is generated by users who stake $AAVE when they mint GHO. The generation of anti-GHO is linear and proportional to the interest accumulated by all GHO borrowers.

Users can use anti-GHO in two ways:

· Burn anti-GHO to mint GHO, thereby repaying debt for free

· Deposit it into the GHO security module to obtain stkGHO

This will increase the alignment of interests of AAVE stakers with GHO borrowers and serve as a preliminary step in a broader revenue sharing strategy.

· Burn & Distribution Schedule

Aave will allow for the redistribution of net excess protocol revenue to token stakers under the following conditions:

· Net holdings of the Aave Collector reach two years of recurring costs for service providers in the last 30 days.

· 90-day annualized revenue of the Aave Protocol reaches 150% of all protocol spend YTD, including the AAVE acquisition budget and the aWETH & aUSDC Umbrella budgets.

Through this program, we will begin to see consistent eight-figure buybacks on the Aave Protocol, a trend that will expand further with further growth of the Aave Protocol.

In addition, $AAVE is almost fully diluted with no major supply unlocks in the future, in stark contrast to recent launches. Many new tokens face severe price declines after their Token Generation Events (TGEs) due to low circulating supply and high fully diluted valuation (FDV) dynamics.

Aave’s Significant Growth Prospects

Aave has multiple growth drivers in the future and is well positioned for the long-term growth of crypto as an asset class. Fundamentally, Aave’s revenue can grow in multiple ways:

Aave V4

Aave V4 will further enhance its capabilities and put the protocol on a path to introduce DeFi for the next billion users. First, Aave will focus on revolutionizing the experience of users interacting with DeFi by building a unified liquidity layer. Aave will remove the complexity of cross-chain lending by enabling seamless access to liquidity on multiple networks, including EVM and future non-EVM networks. The unified liquidity layer will also rely on account abstraction and smart accounts, allowing users to manage multiple positions across isolated assets.

Secondly, Aave will increase the accessibility of the platform by expanding to other blockchains and introducing new asset classes. In June, the Aave community supported the deployment of the protocol on zkSync, marking Aave's entry into the 13th blockchain network. Then in July, the Aptos Foundation put forward a proposal to deploy Aave on Aptos. If the proposal is passed, this will be Aave's first foray into a non-EVM network and further consolidate its position as a true multi-chain DeFi giant. In addition, Aave will also explore products based on real-world assets (RWAs), which 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 culminate in the creation of the Aave Network, which will serve as the core hub for stakeholders to interact with the protocol. GHO will be used to pay fees, while AAVE will become the primary staking asset for decentralized validators. Given that the Aave Network will be developed as either an L1 or L2 network, we expect the market to reprice its tokens accordingly to reflect the additional infrastructure layers being built.

Growth is positively correlated with the growth of BTC and ETH as asset classes

The launch of Bitcoin and Ethereum ETFs this year marked an important turning point in the popularity of cryptocurrencies, providing investors with a regulated and familiar tool to gain exposure without directly holding digital assets. By lowering the barrier to entry, these ETFs are expected to attract a large amount of capital from both institutional investors and retail participants, further promoting the integration of digital assets into mainstream portfolios.

For Aave, the overall growth of the crypto market is a boon as over 75% of its asset base consists of non-stable assets (primarily BTC and ETH derivatives). Therefore, Aave's TVL and revenue growth are directly correlated to the growth of these assets.

Growth is tied to stablecoin supply

We can also expect Aave to benefit 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 away from yield instruments in traditional finance and towards stablecoin farms in DeFi for more attractive yields. Additionally, in a bull market, we can expect higher risk-on behavior, which will increase the utilization of stablecoin lending on platforms such as Aave.

Final Thoughts

To reiterate, we are optimistic about Aave's prospects as a leading project in the decentralized lending market. We further outline the key drivers supporting future growth and detail how each can further expand Aave’s reach.

We also believe that Aave will continue to dominate market share with its strong network effects, driven by the liquidity and composability of its tokens. Upcoming upgrades to its token economics will further improve the security of the protocol and enhance its ability to capture value.

Over the past few years, the market has lumped all DeFi protocols together and priced them as if there is little room for future growth. This is reflected in the trend of Aave’s TVL and revenue run rate rising while its valuation multiples compressing. We believe that this valuation divergence from fundamentals will not last long and that $AAVE currently offers some of the best risk-adjusted investment opportunities in crypto.

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