From ETHLend to Aave V4: The Complete Evolution of Decentralization Lending Protocols

Aave is a leader in the DeFi lending market, with a total locked value of ( TVL ) ranking third among DeFi projects, particularly dominating the lending category. Aave's parent company, Avara, is gradually expanding its business into new areas such as 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 allocated to token holders, and the remaining 3 million are injected into the reserves of the Aave ecosystem. Currently, the total circulating supply of AAVE tokens in the market is approximately 14.8 million.

With the continuous expansion and maturation of Aave's business, both the TVL and price of AAVE have increased against the backdrop of a market recovery in 2024. Avara announced the upgrade plan for the Aave V4 version in May, focusing on further enhancing Aave's liquidity and asset utilization.

The Aave V3 version has basically replaced the V2 version, and the gradual stabilization of its business model and user base has made Aave far ahead of other lending protocols in terms of TVL, trading volume, and the number of supported chains.

Avara has encountered some challenges in expanding its business. Currently, its main revenue still relies on traditional lending operations. The stablecoin GHO has recently regained its peg after a period of depegging. The TVL of the institutional lending platform Aave Arc has remained at a low level after experiencing a sharp decline.

For the future development of Aave, it is recommended to further optimize its cross-chain lending solutions, strengthen its stablecoin business and deeply integrate it with the Aave platform, incorporate Aave's DeFi capabilities into emerging businesses such as social platforms, and integrate the currently relatively independent business segments into a comprehensive ecosystem.

The Development History of Aave

In May 2017, Stani Kulechov founded the ETHLend project. Initially, ETHLend faced serious liquidity challenges during its operation. By the end of 2018, ETHLend underwent a strategic transformation, shifting from a P2P model to a P2C model, introducing a liquidity pool model, and officially rebranding as Aave. This transformation marked the official launch of Aave in 2020.

In November 2023, Aave Companies announced a rebranding 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 strategic布局 in multiple areas such as cryptocurrency wallets and gaming.

The current Aave V3 version has been steadily put into use, and its services have expanded to 12 different blockchains. Meanwhile, Aave Labs is further attempting to upgrade the lending platform, announcing the upgrade proposal for version V4 in May 2024.

According to data provided by Defillama, as of May 15, 2024, AAVE ranks third in the DeFi sector with a total locked value of ( TVL ), reaching $1.0694 billion.

Aave Core Team

Avara is headquartered in London, UK, originally composed of an innovative team of 18 people, and currently LinkedIn shows a total of 96 employees.

• Founder and CEO: Stani Kulechov obtained a Master of Laws degree from the University of Helsinki, with his master's thesis focused on using technology to improve the efficiency of commercial agreements. He is also a Web3 practitioner with a track record of continuous entrepreneurship.

• Chief Operating Officer: Jordan Lazaro Gustave has been in contact with code since his teens and obtained a master's degree in Risk Management from University Paris X Nanterre.

• Chief Financial Officer: Peter Kerr graduated from Massey University and the University of Oxford, having previously worked at HSBC, Deutsche Bank, and Sonali Bank, and joined Avara as CFO in 2021.

• Head of Institutional Business: Ajit Tripathi graduated from IMD Business School and the Indian Institute of Technology, and has previously worked at a trading platform, ConsenSys, and PwC.

Aave's Financing Journey

• In 2017, ETHLend raised $16.2 million through an ICO, during which Aave Companies sold 1 billion units of the LEND token.

• In 2018, the project brand was upgraded to Aave.

• In July 2020, Aave secured a $3 million Series A investment led by Three Arrows Capital.

• In October 2020, Aave raised $25 million in Series B funding and launched the governance token $AAVE.

• In May 2021, the AAVE protocol was deployed on Polygon and will receive a lending mining reward of 200 million USD in Matic provided by Polygon within a year.

Aave's Technical Architecture

Since Aave first debuted in January 2020, it has established its significant position in the decentralized finance ( DeFi ) space with core features such as its lending pools, aToken model, innovative interest rate mechanisms, and flash loan functionality. As Aave evolves from V1 to V3, its lending business model has demonstrated a consistently robust development trend.

In December 2020, Aave released version V2, which significantly enhanced the user experience by simplifying and optimizing its architecture, as well as introducing features such as debt tokenization and Flash Loans V2. According to the official white paper, the architecture optimization in V2 is expected to reduce Gas fees by approximately 15% to 20%. In January 2023, Aave launched version V3, which further improved the efficiency of fund utilization based on V2, with minimal changes to the overall architecture. Version V3 introduced three innovative features: Efficient Mode ( E-mode ), Isolation Mode ( Isolation Mode ), and Portal ( Portal ).

In May 2024, Aave proposed the V4 version proposal, which plans to adopt a brand new architecture in the design of the new version, introducing a unified liquidity layer, blurring interest rate control, native integration of GHO, Aave Network, and other designs.

Borrowing Rate

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

• Optimal Utilization Rate
• Base variable borrowing rate
• Variable Interest Rate Slope 1
• Variable interest rate slope 2
• Stable interest rate slope 1
• Stable interest rate slope 2
• Basic stable loan interest rate
• Stable to the threshold of variable borrowing interest rates
• Threshold for variable to stable borrowing interest rates
• Target Utilization Rate

The formula for variable interest rate calculation is:

Variable borrowing rate = Base variable borrowing rate + Utilization rate * Variable rate slope 1

If utilization > optimal utilization: Variable borrowing rate = Base variable borrowing rate + Optimal utilization rate * Variable rate slope 1 + ( utilization rate - Optimal utilization rate ) * Variable rate slope 2

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

Lending Process

In the interaction process of Aave, the lending process is as follows:

• Depositors can obtain corresponding aTokens by depositing tokens into Aave's asset pool. These aTokens serve as proof of deposit, not only confirming the deposit action but also allowing for free trading and transfer on the secondary market.

• For borrowers, they can borrow cryptocurrencies through over-collateralization or flash loans. When borrowers are ready to repay the debt, in addition to repaying the principal, they also need to pay interest calculated based on the asset utilization rate and market supply and demand conditions. Once the debt is settled, borrowers can not only redeem their collateralized assets, but also the aTokens linked to their collateralized assets will be correspondingly destroyed.

Clearing Mechanism

When the market value of the collateral assets decreases or the value of the borrowed assets increases, causing the value of the borrower's collateral to fall below the established liquidation threshold, Aave's liquidation mechanism is triggered. Different tokens have different loan-to-value ratios (Loan to Value, LTV) and liquidation thresholds based on their risk characteristics. When liquidation occurs, the borrower must pay the principal and interest, as well as a certain percentage of the liquidation penalty (Liquidation Bonus) to the third party executing the liquidation.

Relevant parameters:

• Loan-to-Value Ratio ( LTV ): Determines the maximum amount of assets a borrower can borrow. For example, a 70% LTV indicates that for collateral worth 100 USDT, the borrower can borrow up to 70 USDT.

• Health Factor: Reflects the safety level of the borrowing position. The higher the health factor, the stronger the borrower's ability to repay; conversely, the lower the health factor, the weaker the ability to repay. Once the health factor falls below 1, it indicates that the collateral may face liquidation.

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

Flash Loan

In the Aave protocol, flash loans are a groundbreaking financial innovation that relies on the atomicity feature of Ethereum transactions: all operations in a transaction are either fully executed or not executed at all. This mechanism allows participants to borrow large amounts of assets without the need to provide collateral. Borrowers can borrow funds from Aave for approximately 13 seconds within a block time frame ( and complete repayment within the same block, thus achieving a rapid closure of the borrowing process.

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

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) Credit Delegation Mechanism

Aave launched the credit delegation mechanism in August 2020. Through credit delegation, depositors can delegate their unused credit limits to other users, while borrowers can gain additional borrowing capacity through this.

In addition, Opium launched a Credit Default Swap product (Credit Default Swaps, CDS) in September 2020 targeting Aave's credit delegation mechanism. CDS, as a risk management tool, allows investors to transfer the risk of default from specific borrowers, thereby adding an extra layer of protection to the credit delegation mechanism.

Aave V4 Upgrade Plan

According to the development proposal description of the Aave V4 protocol, Aave V4 will be built with a 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 Flow