Aave: The Core Pillar of Decentralized Finance and On-chain Economy

On-chain lending is one of the most important markets in the crypto industry, and Aave, as the undisputed leader in this market, has strong competitive barriers and user stickiness. It is widely believed in the industry that Aave's value is severely underestimated, and it has enormous growth potential, which the market has not yet fully recognized.

In January 2020, Aave launched on the Ethereum mainnet, marking its 5th year of operation this year. Today, Aave has become the largest lending protocol, with a total active loan amount of $7.5 billion, which is five times that of the second place.

The protocol metrics continue to grow, surpassing the previous cycle high.

Aave is one of the few DeFi protocols that has surpassed the levels of the 2021 bull market. For example, its quarterly revenue has exceeded the peak of the bull market in the fourth quarter of 2021. Notably, even during the market consolidation period from November 2022 to October 2023, Aave's revenue has continued to grow at an accelerated pace. As the market warms up in the first and second quarters of 2024, Aave maintains its momentum, with a month-on-month growth rate of 50-60%.

Since the beginning of the year, thanks to increased deposits and the rising prices of underlying assets such as WBTC and ETH, Aave's TVL (Total Value Locked) has nearly doubled, recovering to 51% of the peak value during the 2021 cycle. This indicates that Aave is more resilient compared to other leading Decentralized Finance protocols.

Strong profit performance reflects a high alignment of the product with the market.

Aave's revenue peaked in the last cycle, coinciding with several smart contract platforms issuing a large amount of token incentives to attract users and liquidity. This brought in unsustainable speculative capital and leverage levels, amplifying the revenue figures of most protocols.

Today, the token incentives of the main chain have been exhausted, and Aave's own token incentives have also dropped to negligible levels. This indicates that the metric growth over the past few months has been organic and sustainable, with the core driving factor being the recovery of market speculation activities, which has pushed up active lending and borrowing rates.

Moreover, even during periods of reduced speculative activity, Aave has demonstrated the ability to drive fundamental growth. In early August, when global risk asset markets plummeted, Aave's revenue remained robust, thanks to its successful collection of liquidation fees during the loan repayment process. This proves that Aave has the capability to withstand market volatility across different collateral types and multi-chain environments.

The fundamentals are strongly recovering, and Aave's price-to-sales ratio is still at its lowest level in three years.

Despite a strong recovery in indicators over the past few months, Aave's price-to-sales ratio is only 17 times, at its lowest level in 3 years, significantly below the median level of 62 times during the same period.

Aave is expected to strengthen its dominance in the Decentralized Finance lending space.

Aave's competitive advantages are mainly reflected in four points:

1. Protocol security management records are good: So far, Aave has not experienced any major smart contract-level security incidents. A good security record brought by strong risk management capabilities is often the primary consideration for DeFi users when choosing lending platforms, especially for whale users who hold large amounts of funds.

2. Bilateral network effects: DeFi lending is a typical two-sided market. Depositors and borrowers constitute the supply and demand sides. Growth on one side drives growth on the other side, making it increasingly difficult for newcomers to catch up. In addition, the more abundant the overall liquidity of the platform, the smoother the liquidity in and out for depositors and borrowers, and the stronger the platform's appeal to large fund users, which can further stimulate the growth of the platform's business.

3. Effective DAO Management: The Aave protocol has fully implemented a DAO-based management model. Compared to centralized team management, DAO involves more comprehensive information disclosure and more thorough community discussions. In addition, Aave's DAO community brings together a group of highly skilled governance professional institutions, such as top risk management service providers, market makers, third-party development teams, and financial advisory teams. This diverse participant structure brings active governance participation to the platform.

4. Multi-chain ecosystem positioning: Aave has been deployed on almost all mainstream EVM L1/L2s, and its TVL remains leading on all deployed chains except for BNB Chain. The upcoming Aave V4 version will enable cross-chain liquidity, further highlighting its advantages in cross-chain liquidity.

Reform the token economics, promote value accumulation, and eliminate reduction risks.

A proposal aimed at reforming the AAVE token economics has been initiated, hoping to introduce a revenue-sharing mechanism to enhance the token's utility.

The first major change is to eliminate the risk of AAVE being reduced when the security module is activated. Based on the brand new Umbrella security module, stkAAVE and stkABPT will be replaced by stk aToken, with the first being aUSDC and awETH. Providers of aUSDC and awETH can choose to stake assets to earn additional fees (including AAVE, GHO, and protocol revenue) on top of the interest paid by borrowers. These staked assets face risks of reduction and destruction during shortage events.

In addition, the revenue distribution mechanism will further increase the demand for AAVE. The introduction of Anti-GHO will replace the current 3% discount enjoyed by stkAAVE users when minting and borrowing GHO. Users can receive Anti-GHO, which can be used in two ways: burn Anti-GHO to mint GHO, which can be used for free debt repayment; or deposit GHO into the security module to obtain stkGHO.

Aave will also allow the redistribution of net excess protocol income to token stakers, but it must meet specific conditions. As a result, the Aave protocol will launch a continuous eight-digit buyback program, which will scale up as the protocol continues to grow.

Aave is expected to achieve significant growth.

Aave has multiple growth drivers in the future and is expected to benefit from the long-term growth trend of cryptocurrency as an asset class. From a fundamental perspective, Aave has several revenue growth avenues:

Aave v4

Aave V4 will further enhance its competitiveness, helping to attract the next wave of one billion users to Decentralized Finance. Aave will focus on revolutionizing the DeFi interaction experience by building a unified liquidity layer. By enabling seamless liquidity access across multiple networks, Aave will simplify cross-chain lending processes. The unified liquidity layer will also deeply integrate account abstraction and smart accounts, allowing users to manage positions of multiple isolated assets.

Aave will also enhance the platform's accessibility by expanding to more chains and introducing more asset classes. Additionally, Aave plans to explore the integration of RWA-based products, which is expected to connect traditional finance with DeFi, attracting institutional investors and injecting a large amount of new capital into the Aave ecosystem.

These developments ultimately gave rise to the Aave Network, which will become the core hub for stakeholders to interact with the Aave protocol. GHO will be used to pay fees, and AAVE will serve as the main staking asset for decentralized validators.

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

The launch of Bitcoin and Ethereum ETFs is an important watershed in the process of cryptocurrency adoption, expected to attract a large amount of capital from both institutions and retail investors, further pushing digital assets into mainstream portfolios.

For Aave, the overall growth of the crypto market is a positive factor, as more than 75% of its asset composition consists of non-stable assets (mainly Bitcoin and Ethereum derivatives). Therefore, Aave's TVL and revenue growth are directly related to the growth of these assets.

Linked to the growth and supply of stablecoins

In the future, Aave is expected to benefit from the growth of the stablecoin market. Central banks around the world may enter a rate-cutting cycle, which could encourage capital to flow out of traditional financial yield instruments and into stablecoin farming in the DeFi sector for higher returns. In addition, during a bull market, investor risk appetite increases, and risk-taking behavior becomes more common, which will further stimulate stablecoin lending activities on platforms like Aave.

Summary

As a leading player in the expanding field of Decentralized Finance, Aave's prospects are optimistic. With strong network effects and outstanding token liquidity and composability, Aave will continue to solidify and expand its market dominance. The upcoming tokenomics upgrade will further enhance the protocol's security and increase its value capture capability.

In recent years, the market has lumped all DeFi protocols together and priced them as an asset class with limited growth potential. This phenomenon is evident from the steady increase in Aave's TVL and revenue while its valuation multiple has decreased against the trend. Industry insiders believe that this mismatch between valuation and fundamentals will not last long. AAVE currently offers an excellent risk-adjusted investment opportunity in the crypto industry.