Aave V4: Scaling Onchain Lending

Really good. Really nice venue and great to be here.

Stablecoins, regulation, liquidity, you know, all the things I love.

Yeah, I think the context for every iteration of the Aave protocol has always been sort of the existing context of where the state of DeFi is at that point. So, we built Aave as a lending protocol. The way Aave works, if there are people who are new to the DeFi space, is that you deposit cryptographic assets, stablecoins, ETH, or tokenized assets, and you can earn interest. You can use them as collateral and then you can borrow as well. Typically users go to Aave to earn yield on stablecoins. That is sort of the biggest use case and I would say 70% of the users using Aave are using it for yield, and the rest are actually the borrowers that create the interest rate that then goes to the depositors. Obviously DeFi has grown significantly over the years. When we started back in 2017, the space was really small. We had fewer users than this room today at that point, and it was very experimental, but the vision was big. Aave had multiple generations. In 2020 we launched the first version and a year later we followed up with Aave V2. V3 was our state-of-the-art protocol focused mainly on capital efficiency, building really good on-chain lending infrastructure that could be used with digital assets. Aave V4 was a creation of this vision that in the future we might have a very diverse set of lending activities on chain directly. That might involve native crypto assets, Bitcoin and Ethereum, but it also might involve more tokenized assets, or might involve lending without any sort of tokenization, lending to the real world effectively. So, we wanted to build something that is extremely modular, has good risk controls, but allows us to extend the protocol into any use cases in the future. That means that if we have a new use case, we don't need a new version of Aave because we can extend the protocol with this hub-and-spoke architecture, where spokes are effectively lending markets and hubs are where the liquidity is stored. The idea is that it is a lending protocol that can be extended to any use cases for institutions, fintechs, and more traditional use cases beyond what we're doing today in DeFi.

All of the existing V3 infrastructure has seen multiple market cycles. We've seen credit cycles, however you want to call them. Aave has been really resilient during really turbulent times. If we look at the October 10th last year where we had a lot of unwinds in the crypto space, also during FTX and a lot of centralized lenders going underwater, and the early DeFi days as well. During these past years, a lot of that risk management experience has accumulated for Aave quite extensively and in DeFi generally. When it comes to development, there are actually very few issues in DeFi protocol smart contracts generally. They are actually third-party dependencies that are related to more traditional infrastructure that might have impact across the DeFi space, like we saw recently. In terms of V3, it allows to create any kinds of markets, has risk management features, allows isolation or collateralization where collaterals aren't borrowed. It really depends on where the demand is and what kind of markets to create for different audiences. V4 is building on the existing audience of DeFi, providing capital efficiency to these native DeFi use cases, but at the same time recognizing that the assets we are going to onboard into Aave and decentralized finance are more issuer-based assets. What I mean is not just only stablecoins, but tokenized assets. Tokenized assets have different risk characteristics compared to native assets like Bitcoin and Ethereum because, for example, you might not have the liquidity on chain, but you need to sort out unwinding and liquidations. With Aave V4, we introduce particular features like risk premiums where you can actually price the risk directly into the collateral without affecting all the borrowers borrowing that stablecoin. It also allows to create very flexible market structures. We have now deployed a prime market which is low risk, a core which is risk-adjusted, and a plus which is risk-return. Within these markets, you can also decide how you share liquidity with each market. So, you have a hub and spokes structure where each spoke has a composition of assets, and then the hubs give credit lines to these spokes up to a certain point. You can think about V4 as a model where you have a central bank that allocates capital and then a commercial bank that basically has a loan book. It's a similar type of relationship and that creates really novel risk mitigation features, but at the same time allows to share some of the liquidity to avoid liquidity bootstrapping issues that we see on an ongoing basis in DeFi with new use cases.

It's extremely hard to build DeFi protocols and really resilient infrastructure and I think the talent in general is very scarce in our space. That's why we have so much consolidation and also the reason why it's better to use something that is already built and battle-tested and resilient and has a really strong community looking after this infrastructure. I think the big difference between what we saw with FTX and DeFi is that traditional models and centralized lenders are acting sort of like black boxes where you don't have much visibility and the trust factor is quite high. There is tooling that improves that, like proof of reserves, that can be applied and makes it easier to understand what is the collateralization in a qualified custodian, for example, and I think that world has improved significantly over the years. But in DeFi, all these code bases and protocols are reviewed by countless people, users, and industry members. I think that is the key difference. When you have a completely auditable and public system, anyone can actually inspect the code and also do different kinds of risk analysis based on that. I think that is the key to building resilient software. In DeFi, we're obviously learning on an ongoing basis and we're far in a better place than we were last year and far better than years ago. I do think there is going to be a trend where a lot of the risk actually moves away even further from the protocols and on chain into off chain, into the actual issued assets. The risk management will happen more on the asset issuer level, for example, when it comes to tokenized assets. That is where traditional risk management tools apply, but we need to figure out how we communicate that transparently back on chain and are able to adjust parameters or safety functions with those assets in mind.

Aave serves a couple of purposes. It is a treasury management tool as well in the sense that you want your treasury to actually yield on an ongoing basis. Where on-chain lending comes into place is that you have the ability to go above the traditional risk curve with collaterals that might be highly liquid and can be liquidated fully to the last position. But at the same time, it opens up a completely new world of building financial primitives or lending markets where you can go higher on the risk curve, but with transparency and auditability that is unprecedented. I think that is where it becomes really interesting for treasury managers. On the retail or commercial side, Aave has been recently integrated into Whop treasury. Whop is basically a platform for creators to actually sell digital goods online and they have huge traction at the moment. One of the products they launched was Whop treasury where creators can use their earnings and put those earnings into a treasury product that is powered by Aave, Betta which is a vault manager, and Plasma, a network where this Aave market is deployed. Why this is interesting is that this was the first biggest fintech integration of DeFi at that scale. It showcases how easy it is to plug into DeFi down the line. The benefits here are that the more fintechs and asset managers and treasuries are using and plugging into DeFi, the network effects scale. That means there's more liquidity to withdraw, there's cheaper cost of capital for borrowers to utilize, and you get compounding effects that you don't really find in traditional finance.

Yeah, that's the vision. Where we are now is in early phases of that journey. Aave Horizon has roughly half a billion worth of assets and this Aave Horizon market is purely and exclusively for supplying tokenized assets as collateral and borrowing stablecoins, effectively cash. Many of these tokenized assets are existing issued assets that already exist on chain. But down the line, where we expect this utility to evolve, is that you could issue direct financial instruments and assets on chain and benefit with Aave directly by borrowing capital and using that capital directly in traditional markets. Aave Horizon has actually been a really useful product for a lot of borrowers, especially during the October 10th when things were moving really quickly, markets were moving fast. The way to actually, if you already have money market funds on chain or T-bills on chain, and you are able to use that as collateral and draw liquidity, that helps to reposition a lot of these positions. It's been used by market makers already, asset managers as well, and it's a product that we see quite a lot of future in, especially as more assets come on chain.