Original title: Aave - the core pillar of decentralized finance and on-chain economy

Author: 0xArthur, founder of DeFiance Capital; Translated by 0xxz@Golden Finance

Aave is the largest and most proven lending protocol

As the undisputed leader in the on-chain lending category, Aave has an extremely strong and sticky moat, and we believe that as a category leader in one of the most important areas of cryptocurrency, Aave is severely undervalued and has huge room for growth in the future that the market has yet to catch up with.

Aave launched on the Ethereum mainnet in January 2020 and is celebrating its 5th year of operation this year. Since then, it has become one of the most battle-tested protocols in the DeFi and lending space. This is amply demonstrated by the fact that Aave is currently the largest lending protocol with $7.5 billion in active loans, 5 times the volume of the second largest protocol, Spark.

Data as of August 5, 2024

The protocol index continues to grow and has exceeded the highest value of the previous cycle

Aave is also one of the few DeFi protocols that has exceeded the 2021 bull run indicators. For example, its quarterly revenue has exceeded the revenue in Q4 2021 at the peak of the bull run. Notably, revenue growth continued to accelerate despite the market going sideways from November 22 to October 23. As the market picks up in Q1 and Q2 2024, growth continues to be strong, increasing by 50-60% month-on-month.

Source: Token Terminal

Year-to-date, Aave TVL has nearly doubled, driven by increased deposits and higher token prices for underlying collateral assets like WBTC and ETH. As a result, TVL has recovered to 51% of its 21-cycle peak level, making it more resilient than other top DeFi protocols.

Data as of August 5, 2024

Excellent earnings quality indicates product-market fit

Aave’s revenue peaked in the last cycle when multiple smart contract platforms such as Polygon, Avalanche, and Fantom invested heavily in token incentives to attract users and liquidity. This led to unsustainable levels of employed capital and leverage, which supported the revenue figures of most protocols during this period.

Fast forward to today, token incentives from major public chains have dried up, and Aave’s own token incentives have fallen to negligible levels.

Source: Token Terminal

This suggests that the growth in the indicator over the past few months is organic and sustainable, driven mainly by the return of speculative activity in the market, which has pushed up active lending and borrowing rates.

Furthermore, Aave has demonstrated its ability to grow fundamentals even during periods of subdued speculative activity. During the global risk asset market crash in early August, Aave’s revenue remained resilient as it successfully earned liquidation fees when loans were repaid. This also demonstrates its ability to withstand market volatility across different collateral bases and on-chain.

Data as of August 5, 2024 Source: TokenLogic

Aave trades at three-year low P/E despite strong fundamental recovery

Despite the strong recovery in the metrics over the past few months, Aave's price-to-sales (P/S) ratio remains as low as 17x, falling to its lowest level in 3 years and well below the 3-year median of 62x.

Source: Coingecko, Token Terminal

Aave is poised to expand its dominance in decentralized lending

Aave's moat mainly consists of the following 4 points:

1. Record of protocol security management: Most new lending protocols will encounter security incidents in the first year of operation. Aave has not had a major smart contract-level security incident to date. The platform’s robust risk management is often the primary consideration for DeFi users to choose a lending platform, especially large users with strong financial resources.

2. Bilateral network effect: DeFi lending is a typical bilateral market. Depositors and borrowers constitute both the supply and demand sides. The growth of one side will stimulate the growth of the other side, making it increasingly difficult for later competitors to catch up. In addition, the more sufficient the overall liquidity of the platform, the smoother the liquidity in and out of depositors and borrowers, the more attractive it is to large capital users, thereby stimulating further growth of the platform business.

3. Excellent DAO management: The Aave protocol fully implements DAO management. Compared with the centralized team management model, DAO management information disclosure is more comprehensive and community discussions on major decisions are more in-depth. In addition, Aave's DAO community has a number of professional institutions with high governance levels, including top risk control service providers, market makers, third-party development teams, financial advisory teams, etc. The sources of participants are diversified and the degree of governance participation is higher.

4. Multi-chain ecological positioning: Aave is deployed on almost all mainstream EVM L1/L2 chains, and its TVL (total locked value) is in a leading position on all deployment chains except BNB Chain. In the upcoming Aave V4 version, cross-chain liquidity will be linked to make the advantages of cross-chain liquidity more prominent. See the figure below for details:

Data as of August 5, 2024 Source: DeFiLlama

Improve token economics to drive value accrual and eliminate slashing issues

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

The first major shift is removing the risk of slashing AAVE when mobilizing the security module.

● Currently, $AAVE (stkAAVE - $228M TVL) and Balancer LP tokens in the $AAVE/$ETH security module (stkABPT - $99M TVL) are at risk of having tokens slashed to cover shortfall events.

● However, stkAAVE and stkABPT are not good coverage assets due to the lack of correlation with the collateral assets that generate bad debts. $AAVE will also cycle through reduced coverage in such events.

● Under the new Umbrella security module, stkAAVE and stkABPT will be replaced by stk aTokens starting with aUSDC and awETH. aUSDC and awETH providers can choose to stake their assets to earn additional fees (in $AAVE, $GHO (protocol revenue) plus interest earned by borrowers. In the event of a shortfall event, these staked assets may be slashed and burned.

● This arrangement is beneficial for platform users and $AAVE token holders.

Additionally, there are more demand drivers for introducing $AAVE through a revenue sharing mechanism.

● Introducing anti-GHO

Currently, stkAAVE users can enjoy a 3% discount on both minting and borrowing GHO.

This will be replaced by a new “anti-GHO” token generated by stkAAVE holders who mint GHO. Anti-GHO generation is linear and proportional to the interest accrued by all GHO borrowers.

Users can claim Anti-GHO and use it in two ways: burn Anti-GHO to mint GHO, which can be used to repay debts for free, and deposit into stkGHO's GHO security module

This increases alignment between AAVE stakers and GHO borrowers and will be the first step in a broader revenue sharing strategy.

● Burning and distribution procedures

○ Aave will allow redistribution of net excess protocol revenue to token stakers, subject to the following conditions:

■ Aave Collector Net Holdings are the recurring costs of 2 annual service providers over the last 30 days.

■ Aave Protocol 90-day annualized revenue is 150% of all protocol spend YTD, including the AAVE acquisition budget and the aWETH and aUSDC umbrella budgets.

From that point on, we will begin to see Aave Protocol buyback volumes consistently in the 8 figures, and will grow further as the Aave Protocol continues to grow.

Furthermore, AAVE is almost fully diluted with no significant future supply unlocks, in stark contrast to recently launched tokens which saw losses at the time of their Token Generation Events (TGEs) due to the low circulation high fully diluted valuation (FDV) dynamic.

Aave is poised for significant growth in the future

Aave has multiple growth factors in the future, and it is also expected to benefit from the long-term growth of cryptocurrencies as an asset class. Fundamentally, Aave's revenue can grow in multiple ways:

Ave v4

Aave V4 will further enhance its capabilities and put the protocol on track to attract the next billion users to DeFi. First, Aave will focus on revolutionizing the experience of users interacting with DeFi by building a unified liquidity layer. By enabling seamless liquidity access across multiple networks (EVM and eventually non-EVM), Aave will eliminate the complexity of cross-chain conversions for borrowing and lending. The unified liquidity layer will also rely heavily on account abstraction and smart accounts to allow users to manage multiple positions across isolated assets.

Secondly, Aave will increase the accessibility of its platform by expanding to other chains and introducing new asset classes. In June, the Aave community endorsed the deployment of the protocol on zkSync. The move marked Aave's entry into its 13th blockchain network. Soon after, in July, the Aptos Foundation drafted a proposal to deploy Aave on Aptos. If approved, the deployment on Aptos would be Aave's first foray into a non-EVM network and would further solidify its position as a true multi-chain DeFi powerhouse. In addition, Aave will also explore integrating RWA-based products that will be built around GHO. This move has the potential to connect traditional finance with DeFi, attract institutional investors and bring a large amount of new capital to the Aave ecosystem.

These developments culminated in the creation of the Aave Network, which will serve as the central hub for stakeholders to interact with the protocol. GHO will be used to collect 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 an asset class

The launch of Bitcoin and Ethereum ETFs this year was a watershed moment for cryptocurrency adoption, providing investors with a regulated and familiar vehicle to invest in digital assets without directly owning them. By lowering barriers to entry, these ETFs are expected to attract significant capital from both institutional and retail participants, further facilitating the inclusion of digital assets in mainstream portfolios.

Given that over 75% of Aave’s asset base consists of non-stablecoin assets (primarily BTC and ETH derivatives), growth in the broader cryptocurrency market is a boon to Aave. 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 could catalyze a shift in capital from traditional financial yield instruments to stablecoin farming in DeFi for more attractive yields. Additionally, we can expect higher risk-seeking behavior in bull markets, which could help increase the borrowing utilization of stablecoins on platforms like Aave.

Final Thoughts

To reiterate, we are bullish on Aave’s prospects as a leading project in the large and growing decentralized lending market. We further outline the key drivers underpinning future growth and detail how each driver can further scale.

We also believe that Aave will continue to dominate market share as it has built a strong network effect, thanks to the liquidity and composability of the tokens. Upcoming tokenomics upgrades should help further improve the security of the protocol and further enhance its value capture aspects.

Over the past few years, the market has lumped all DeFi protocols together and priced them as protocols with little future growth. Aave's TVL and revenue run rate are trending upwards while its valuation multiple is compressing, which speaks volumes about this. We believe this misalignment between valuation and fundamentals will not last long, and AAVE now offers some of the best risk-adjusted investment opportunities in the crypto space.

Original link: https://x.com/Arthur_0x/status/1825595598609023039