Decentralized lending stands as one of the most critical sectors within the crypto industry. As the undisputed leader in this market, Aave possesses formidable competitive advantages and strong user loyalty. We believe Aave is significantly undervalued, harboring immense growth potential that the market has yet to fully recognize.
Launched on the Ethereum mainnet in January 2020, Aave is now in its fifth year of operation. Today, it reigns as the largest lending protocol, with active loans totaling $7.5 billion—five times greater than its closest competitor, Spark.
Protocol Metrics Show Sustained Growth Exceeding Previous Cycle Highs
Aave is among the few DeFi protocols whose key metrics have surpassed their 2021 bull market peaks. For instance, its quarterly revenue has already exceeded the high set in Q4 2021. Notably, even during the market consolidation period from November 2022 to October 2023, Aave's revenue continued to grow at an accelerating pace. As markets recovered in Q1 and Q2 of 2024, Aave's momentum remained strong, with quarterly growth reaching 50-60%.
Year-to-date, thanks to increased deposits and rising prices of underlying assets like WBTC and ETH, Aave's Total Value Locked (TVL) has nearly doubled, recovering to 51% of its peak from the 2021 cycle. This indicates that Aave has demonstrated greater resilience compared to other leading DeFi protocols.
Strong Profitability Reflects Strong Product-Market Fit
Aave's revenue peak in the last cycle coincided with a period when multiple smart contract platforms, such as Polygon, Avalanche, and Fantom, were distributing substantial token incentives to attract users and liquidity. This influx led to unsustainable levels of speculative capital and leverage, artificially inflating the revenue figures for many protocols.
Today, token incentives from major chains have largely dried up, and Aave's own token incentives have been reduced to negligible levels. This indicates that the recent growth in metrics is organic and sustainable, driven primarily by a resurgence in market speculation, which has increased active loans and borrowing rates.
Furthermore, even during periods of reduced speculative activity, Aave has shown an ability to drive fundamental growth. Amid global market volatility in early August, Aave's revenue remained robust, bolstered by successfully collected liquidation fees during loan repayments. This demonstrates Aave's capability to withstand market fluctuations across various types of collateral and multiple chains.
Despite Strong Fundamentals, Aave's P/S Ratio Hits Three-Year Low
Despite several months of strong metric recovery, Aave's price-to-sales (P/S) ratio stands at just 17x, a three-year low. This is significantly below the median level of 62x seen during the same period, suggesting a potential market undervaluation.
Aave Poised to Strengthen Its Dominance in Decentralized Lending
Aave's competitive advantages are manifested in four key areas:
- Strong Security Track Record: Most new lending protocols encounter security issues in their early stages. To date, Aave has not experienced any major smart contract-level security incidents. This strong risk management record is often a primary consideration for DeFi users choosing a lending platform, especially for large-scale "whale" users holding significant capital.
- Two-Sided Network Effects: DeFi lending is a classic two-sided market. Depositors and borrowers constitute the supply and demand sides. Growth on one side stimulates growth on the other, making it increasingly difficult for newcomers to catch up. Moreover, greater overall platform liquidity ensures smoother transactions for both depositors and borrowers, enhancing its appeal to large-volume users and further stimulating business growth.
- Effective DAO Governance: The Aave protocol is now fully managed by a Decentralized Autonomous Organization (DAO). Compared to centralized team management, DAO governance involves more comprehensive information disclosure and thorough community discussion. Furthermore, Aave's DAO community comprises highly proficient professional institutions, including top risk management service providers, market makers, third-party development teams, and financial advisory groups. This diverse participant structure brings vibrant and active governance participation.
- Multi-Chain Ecosystem Positioning: Aave has been deployed on nearly all mainstream EVM-compatible Layer 1 and Layer 2 networks. On all deployed chains except BNB Chain, it maintains a leading TVL position. The upcoming Aave V4 version aims to unify cross-chain liquidity, further solidifying its advantage in this area.
Reforming Tokenomics to Enhance Value Accumulation and Mitigate Risks
The Aave Chan Initiative (ACI) recently proposed a significant overhaul of AAVE tokenomics, aiming to introduce a revenue-sharing mechanism to enhance the token's utility.
A major proposed shift involves eliminating the risk of AAVE token slashing when the Safety Module is activated.
- Currently, stakers of AAVE tokens (stkAAVE - $228M TVL) and AAVE/ETH Balancer LP tokens (stkABPT - $99M TVL) face the risk of their tokens being slashed to cover shortfall events.
- However, stkAAVE and stkABPT lack correlation with the collateral assets that accumulate bad debt, making them less than ideal coverage assets. Selling pressure on AAVE during such events could further reduce the coverage level.
- Based on a new Umbrella Safety Module, stkAAVE and stkABPT would be replaced by stk aTokens, initially aUSDC and aWETH. Suppliers of aUSDC and aWETH can choose to stake their assets to earn additional fees (including AAVE, GHO, and protocol revenue) on top of the interest paid by borrowers. These staked assets would then be at risk of slashing and burning during a shortfall event.
- This new arrangement is designed to benefit both platform users and AAVE holders.
Additionally, a new revenue distribution mechanism aims to further boost demand for AAVE.
Introducing Anti-GHO:
- Currently, stkAAVE users enjoy a 3% discount when minting and borrowing GHO.
- This would be replaced by a new "anti-GHO" token, generated by stkAAVE holders who mint GHO. Its generation is linear, proportional to the accumulated interest from all GHO borrowers.
- Users can claim anti-GHO and use it in two ways: burn it to mint GHO for free debt repayment, or deposit it into the GHO Safety Module to obtain stkGHO.
- This enhances the alignment of interests between AAVE stakers and GHO borrowers and serves as a first step toward a broader revenue-sharing strategy.
Burn and Distribution Plan:
- Aave would allow net excess protocol revenue to be redistributed to token stakers, subject to conditions: the Aave Collector's net holdings must equal the recurring costs for two years of service providers over the past 30 days, and the protocol's 90-day annualized revenue must reach 150% of all year-to-date protocol expenses.
This would initiate an ongoing 8-figure buyback program for AAVE, with the scale growing alongside the protocol.
Furthermore, AAVE's circulating supply is nearly fully diluted, with no large-scale unlocks anticipated. This contrasts sharply with recent token launches that have experienced significant value erosion post-Token Generation Event (TGE) due to low float and high Fully Diluted Valuation (FDV).
Aave's Path to Significant Growth
Aave has multiple growth drivers ahead. Leveraging its current dominant position, it is well-positioned to benefit from the long-term growth trend of cryptocurrency as an asset class. Fundamentally, Aave has several avenues for revenue growth:
Aave V4 Upgrade
Aave V4 is designed to significantly enhance its competitiveness and help onboard the next billion users to DeFi. Key improvements include:
- Unified Liquidity Layer: Aave aims to revolutionize the DeFi interaction experience by building a unified liquidity layer. This will enable seamless access to liquidity across multiple networks (including EVM and eventually non-EVM chains), simplifying the cross-chain borrowing and lending process. This layer will also deeply integrate Account Abstraction and Smart Accounts, allowing users to manage positions across multiple isolated assets effortlessly.
- Expanded Accessibility: The protocol plans to increase its reach by deploying on more chains and integrating more asset classes. The community recently voted to deploy on zkSync (its 13th blockchain) and is considering a proposal for deployment on Aptos, which would mark its first entry into a non-EVM network, cementing its status as a true multi-chain DeFi powerhouse. 👉 Explore more strategies for cross-chain DeFi
- Real-World Assets (RWA): Aave is exploring the integration of RWA-based products built around its native stablecoin, GHO. This initiative aims to bridge traditional finance with DeFi, potentially attracting institutional investors and injecting substantial new capital into the Aave ecosystem.
These developments are expected to culminate in the Aave Network, which will serve as the central hub for stakeholders to interact with the protocol. GHO would be used for fee payment, and AAVE would act as the primary staking asset for decentralized validators. As the Aave Network is developed as an L1 or L2, a market revaluation of its token is anticipated to reflect the value of this new infrastructure layer.
Correlation with Bitcoin and Ethereum Growth
The successful launch of Bitcoin and Ethereum ETFs represents a significant milestone in cryptocurrency adoption. These regulated, traditional investment vehicles provide an easier way for investors to gain exposure to digital assets, bypassing the complexities of direct ownership. By lowering the barrier to entry, these ETFs are expected to attract substantial capital from both institutional and retail investors, further integrating digital assets into mainstream portfolios.
This overall market growth is a net positive for Aave. Over 75% of its asset composition consists of non-stable assets, primarily Bitcoin and Ethereum derivatives. Therefore, Aave's TVL and revenue growth are directly correlated with the appreciation of these core assets.
Tied to Stablecoin Supply Growth
Aave is also poised to benefit from the growth of the stablecoin market. As global central banks signal potential interest rate cuts, the opportunity cost for investors seeking yield decreases. This may incentivize capital to flow out of traditional yield instruments and into stablecoin yield farming within DeFi. Furthermore, during bull markets, increased risk appetite and more prevalent risk-seeking behavior typically stimulate stablecoin borrowing activity on platforms like Aave.
Frequently Asked Questions
What is Aave and how does it work?
Aave is a leading decentralized finance (DeFi) protocol that enables users to lend and borrow a wide variety of cryptocurrencies. Lenders deposit assets into liquidity pools to earn interest, while borrowers can take out overcollateralized loans from these pools. The protocol uses smart contracts to automate these processes, eliminating the need for a traditional financial intermediary.
Why is Aave considered a leader in DeFi lending?
Aave holds a dominant market position with a TVL and active loan volume significantly larger than its nearest competitors. Its advantages include a strong security record, powerful network effects, proficient DAO governance, and a widespread multi-chain presence. These factors create significant barriers to entry for competitors and foster strong user loyalty.
What are the main risks associated with using Aave?
The primary risks involve smart contract vulnerabilities, though Aave has a strong audit history, and the volatility of crypto collateral, which can lead to liquidations if collateral value drops too sharply relative to the loan value. Users should also be aware of the regulatory landscape surrounding DeFi protocols, which is still evolving.
How does the proposed tokenomics upgrade benefit AAVE holders?
The proposed upgrade aims to enhance value accrual for AAVE holders by introducing mechanisms like revenue sharing from protocol fees and a buyback program. It also seeks to improve the safety module's efficiency by staking interest-bearing aTokens instead of AAVE directly, potentially reducing sell pressure during market stress events.
What is GHO and how is it related to Aave?
GHO is Aave's native, decentralized, overcollateralized stablecoin. Users can mint GHO by depositing collateral into the protocol. It is integral to Aave's ecosystem, and future developments, including potential Real-World Asset (RWA) products, are expected to be built around it, creating more utility and demand.
How does Aave plan to handle cross-chain lending?
The upcoming Aave V4 upgrade plans to introduce a unified liquidity layer. This innovation is designed to seamlessly connect liquidity across different blockchains, allowing users to borrow assets on one chain using collateral deposited on another, significantly simplifying the cross-chain lending experience.
Conclusion
In summary, we maintain an optimistic outlook for Aave, the steadily growing leader in the decentralized lending space. We have detailed the core elements driving its future growth and analyzed how each factor contributes to its expansion.
We believe that Aave, with its powerful network effects, exceptional token liquidity, and composability, will continue to consolidate and expand its market dominance. The forthcoming tokenomics upgrade is expected to further enhance the protocol's security and its ability to capture value.
In recent years, the market has often lumped all DeFi protocols together, pricing them as an asset class with limited growth potential. This is evident in Aave's rising TVL and revenue alongside declining valuation multiples. We believe this disconnect between valuation and fundamentals is unlikely to persist. AAVE currently presents one of the most compelling risk-adjusted investment opportunities within the crypto industry.