Looking Back at DeFi (Part 2): What is AAVE – The Market Leading Decentralized Bank Doing?

Looking Back at DeFi (Part 2): What is AAVE – The Market Leading Decentralized Bank Doing?

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2022-08-08 13:55:43

The reason DeFi is booming is because it can bring ordinary financial entities and activities into the crypto world, leveraging blockchain technology to add features of decentralization, unattended and other benefits. other benefits to users. One of the successful simulation projects of banks’ operations is AAVE. In today’s post, let’s take a look back at AAVE in the first half of 2022!

Learn about AAVE

If you don’t know, AAVE is a project in the Lending – Borrowing segment. The operation mechanism of AAVE is completely similar to a regular bank. You can participate in the protocol as a depositor (an asset provider) or a borrower (borrower). AAVE is an intermediary that controls the cash flow deposited by depositors and does business (lending) to generate profits, part of the profit will be divided among depositors, part will belong to the protocol.

Describe the simple operation of the protocol. Source: AAVE

Recent important updates

Aave v3

In the first half of 2022, AAVE focuses on continuing to improve the product, with the launch of testnet and mainnet of AAVE v3.

AAVE v3 is built to make AAVE the most powerful, advanced, secure and efficient DeFi protocol. V3 is described as offering higher capital efficiency, increased security, and cross-chain functionality.

Some of the new features of V3 include:

– High Efficiency Mode: Allows users to max out collateral on AAVE, resulting in higher profits.

– Isolation Mode: Limit the risk and risk to the protocol from newly added assets to the protocol by only allowing borrowing up to a specific amount.

– Risk Management Improvements: Provides additional protection for the protocol through various risk limits and other tools;

– L2-Specific Features: Layer 2 network-specific designs to improve user experience and reliability;

– Portal: Allows content to flow seamlessly between Aave V3 marketplaces across different networks (note that this feature will only be available on mainnet deployment);

– Community Contribution: Facilitate and encourage community use through a well-organized, modular codebase.

– Gas Optimization: Gas costs of all functions are reduced by about 20-25% on a large scale.

Stablecoins GOOD

One news that surprised the DeFi community at the time it was announced was that Aave would build a decentralized stablecoin called GHO. This proposal has now been approved by the Aave community and the preparation process will be accelerated by the Aave team in the near future.

To learn more about GHO, readers can refer to the article below of CHK.

Metrics achieved by the protocol

About Total Value Locked (TVL)

TVL on AAVE is being split separately for each version:

TVL of AAVE. Source: DefiLlama

As you can see, AAVE’s TVL focuses mainly on V2 and V3, the figures at V1 and AAVE Arc are not significant. Therefore, we will focus on analyzing the operation of AAVE on V2 and V3.

TVL on AAVE V2. Source: DefiLlama
TVL on AAVE V3. Source: DefiLlama

Thus, from the beginning of 2022 until now, TVL on AAVE V2 has decreased from about 13.4 billion USD to only 5.3 billion USD, equivalent to a decrease of 60.4%. In contrast, since the mainnet launch (March 2022), TVL on AAVE V3 has grown from about $67 million (since April) to nearly $1.2 billion, equivalent to an increase of nearly 18 time.

Thus, the decrease of TVL in AAVE V2 is caused by the declining market situation (the price of coins/tokens plummeted, causing TVL to anchor the value of those coins on AAVE to also decrease), but a part of the TVL from V2 has been lost. ported to V3 to take advantage of new features.

Analyze TVL on AAVE V2 and V3. Source: DefiLlama

Thus, although the focus of AAVE’s development is still Ethereum, we can also see that the project has expanded on many other ecosystems, including quite hot chains such as Polygon, Avalanche, Optimism, etc. Arbitrum. This move of AAVE in my opinion has 2 meanings:

Dominate a new market

Normally, each ecosystem to develop needs to build enough puzzle pieces (AMM, Lending, Launchpad, Yield Farming…). New ecosystem projects are often nascent and easily overtaken. Therefore, AAVE has quickly expanded to capture new markets, ensuring that no matter which ecosystem explodes, AAVE will also benefit.

Looking for a better market

It is no coincidence that in the expanded list of AAVE there are 3 names about Layer-2: Arbitrum, Optimism and Polygon. Ethereum, despite many updates, is still quite expensive, especially “peak”. The deployment of AAVE on Layer-2 and the new ecosystem is also a test step to find a more efficient market.

Effective use of capital

AAVE operates under a banking business model, so capital efficiency is very important.

Funds mobilized from users, investment funds are the source of low-cost capital, while loan capital is the source of profit-generating capital (the interest rate is higher than the interest rate payable for mobilized capital). . Therefore, the higher the ratio of loan amount/total mobilized amount, the better the capital efficiency.

However, because it is a protocol that operates under a mortgage loan model combined with liquidation, and the crypto market is very volatile, the ratio of loan amount / total deposit cannot be too high because it will risk of mass liquidation. In my opinion, to be considered effective, lending protocols need to maintain a minimum rate of 50%.

Together, we will analyze AAVE’s capital efficiency on the most prominent ecosystems:

Data is calculated as of August 3, 2022. Source: AAVE

Note: If you have any questions about the data, I will explain that the TVL that I quoted from DefiLlama above is only calculated based on the available amount, not on the total amount and loan amount..

Thus, AAVE’s lending performance on Avalanche is quite impressive when reaching 55.3%, followed by Ethereum and Polygon. However, because the proportion of capital on Ethereum accounts for the majority, so in general AAVE this period is underperforming.

The reason for this situation, in my opinion, is mainly due to the fluctuations of the market over the past time. When a series of crypto assets are sharply reduced, it will lead to liquidation risk, in order to reduce the risk of liquidation, borrowers need to pay most of the debt => the total amount of the loan decreases sharply. In addition, the outflow of money from the market into stablecoins also reduces the demand for loans.

Protocol revenue

To analyze AAVE’s revenue, we will use Token Terminal’s data

AAVE’s revenue. Source: Token Terminal

To make it easier for you to understand, I will explain a little more:

Total Revenue: is calculated based on the total interest paid by the borrower (borrower) for the protocol.

Supply-side Revenue: is calculated based on the total amount of interest that the protocol has to pay to the asset providers (or lenders).

Thus, actual revenue earned by AAVE = Total Revenue – Supply side Revenue

After comparing, I found that this revenue of AAVE will fall somewhere around 50,000 USD/day on average, equivalent to about 1.5 million USD/month. Of course, you can see that in the period from May back here, AAVE’s revenue in general declined quite a lot, only reaching about 20,000 – 30,000 USD/day.

As I analyzed above, currently, the demand for loans in the market is quite small, so AAVE’s decrease in revenue and profit is almost certain. However, if it is able to maintain the above revenue level even in difficult times, it is not too difficult for AAVE to survive through the downtrend.


From the above analysis, we can draw some conclusions for AAVE as follows:

The first: AAVE is still focusing on improving the product better, and at the same time deploying to dominate the market through building multi-chain.

This has the advantage of making the protocol wider, making users more aware of the brand and using the protocol, and any ecosystem that has deployed explosively will benefit from AAVE. However, the downside will be that TVL on the protocol is spread out, requires a cross-chain solution to support, as well as being vulnerable to attacks. Recently, AAVE has proposed to withdraw from Fantom also because of security concerns.

Monday: AAVE V3 is showing more positive steps.

The stats on V3 are relatively stable, despite the market decline. This is probably a positive point for AAVE in the past as they have shown improvements in V3 to help retain users and increase capital efficiency.

Tuesday: AAVE needs to improve capital efficiency.

Although V3 has positive signs, however, AAVE V2 still accounts for a large proportion of TVL and as we have analyzed, the capital efficiency of the protocol is not high. This comes from objective reasons (the market goes down, many people need to pay down loans to avoid liquidation; the demand for loans decreases …), but it is impossible not to admit that AAVE has not yet had an effective solution. effective to stimulate borrowers (reducing loan interest rates, attractive incentive programs such as retroactive, etc.)

Wednesday: AAVE still exists, so we have a right to hope.

Unlike other dying projects, AAVE’s revenue is still positive, and the revenue is still stable.

This is the premise for you to hope that AAVE will continue to exist, develop and defeat competitors in difficult times, and then explode when the market “uptrend” returns.

Thursday: The AAVE token needs more practical uses.

Similar to Uniswap’s UNI, AAVE currently has quite a few use cases. AAVE is mainly used for administration (governance), a part of the fee is reduced (when using AAVE as collateral), a part of AAVE is burned based on the revenue of the protocol… In my opinion, these are not really valuable use-cases. for a token. AAVE needs more than that to explode. Stablecoin GHO could be created to add this aspect to Aave.

Thus, we have together “looked back at AAVE”. What is your opinion about this protocol? Which project would you like me to write more about? Leave a comment! See you guys in the next posts!


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