The Aave V3 market launched on Ethereum in late January, accumulating over $1 billion in deposits and $350 million in outstanding loans by quarter-end.
AAVE Companies released recommendations for GHO Parameters, including a 25% discount on borrow rates for stkAAVE holders.
The $ARB airdrop contributed to a 305% increase in outstanding loan balance on Arbitrum, with AAVE DAO receiving approximately 2.7 million ARB in its treasury.
The forthcoming AAVE Governance V3 introduces Aave Robot and Cross-Chain Infrastructure, revolutionizing Aave's voting process and cross-chain communication capabilities.
Despite a 34% decrease in daily active users in Q1, the numbers still represent at least a 17% increase compared to any of the first three quarters of 2022.
Primer on Aave
Aave is a decentralized money market protocol that facilitates the depositing and borrowing of various crypto assets. The protocol has two main versions (Aave V2 and V3) and is deployed across various Layer-1 (L1) chains and Layer-2 (L2) networks, with the majority of activity on Ethereum. Aside from the core permissionless lending business, the protocol has introduced various complementary products such as a stablecoin (GHO), an open social protocol (Lens Protocol), and a permissioned instance of the core Aave protocol (Aave Arc).
Key Metrics
Performance Analysis
Total Value Locked
As crypto prices rebounded from the Q4 lows, the value supplied on Aave increased by 45% in Q1, even amidst the mounting regulatory pressures. A significant shift occurred at the token level, with a $304 million decrease in USDC, accompanied by a $205 million increase in USDT. During the brief USDC depeg event in March, approximately $221 million USDC was withdrawn from Aave markets within 24 hours, and an additional $256 million was withdrawn by the end of the quarter. Conversely, ETH and its staking derivatives remained the dominant source of collateral on Aave, with their market share of deposits expanding from 42% to 50%.
Asset Flows
The Aave protocol began 2023 on a high note with the launch of the highly anticipated V3 market on Ethereum. In just over two months, the new market exceeded $1 billion in value deposited and closed the quarter with $350 million in outstanding loans. Along with V3 on Ethereum, the Arbitrum deployment experienced a notable increase in asset flows, resulting in a 305% growth in outstanding loans, climbing from $21 million to $83 million. This surge was primarily driven by Arbitrum's ARB airdrop in March, which resulted in AAVE DAO’s treasury receiving approximately 2.7 million ARB. While token allocations have not yet been decided, the DAO recently conducted an initial vote on the usage of ARB and made plans for further discussions in the community forum.
Usage
In Q1, Aave's daily active users (DAUs) decreased 34% after increasing 78% in Q4. The most significant reductions occurred on Optimism V3 (59%) and Polygon V3 (50%). These two deployments also saw the largest increases in Q4, at 274% and 209%, respectively. The concentration of DAU losses suggests that a substantial number of users likely shifted their capital to Arbitrum in anticipation of a potential ARB liquidity mining program. Despite the QoQ decline, DAUs in Q1 still increased by at least 17% compared to any of the first three quarters of 2022.
Revenue
In Q1, protocol interest revenues were on pace to be within 1% of Q4 earnings until the USDC depegging event in March. The subsequent three days of heightened activity generated $305,000 in interest revenue for the DAO, accounting for 13% of Q1's total. Over 65% of this revenue came from USDT markets as USDC holders flocked to the most liquid stablecoin. The stampede temporarily pushed the USDT borrow rate up to 87% on the Ethereum V2 market. Interest revenues from ETH also surged, rising 82% QoQ to $811,000. Combined, ETH, USDT, and USDC constituted 80% of Q1 revenue, up from 65% in Q4.
Borrower Perspective
Ethereum's shift to the Proof-of-Stake (PoS) model led to the emergence of liquid staking tokens (LSTs), which allow investors to earn validator rewards without the need to directly run a node or lock Ether.Lido Finance's Staked Ether (stETH), backed 1:1 with ETH staked on the Beacon Chain, accumulates rewards daily through rebasing. stETH has become the preferred collateral on Ethereum V2, as its staking reward rates, paid in stETH, often exceed ETH borrow rates. This dynamic has led to stETH being viewed as self-repaying collateral.
The introduction of V3 on Ethereum brought support for wstETH. This improved version of stETH bakes staking rewards into the price through the exchange rate, rather than rebasing. The community subsequently voted to add wstETH support on Arbitrum and Optimism as well.
In terms of base performance, the leveraged ETH strategy yielded the highest annualized return of 2.59% on Optimism, followed by 1.53% on Ethereum V2. Although Ethereum V2 had lower borrowing costs for ETH, V3 offers enhanced capital efficiency with greater loan-to-value ratios.
Until recently, BTC and ETH borrow rates tended to be more closely aligned, with the difference between the weighted ETH and BTC borrow rates averaging just 22 basis points in Q4. The emergence of the liquid staking token (LST) narrative and the growing popularity of the leveraged ETH strategy caused a shift in this trend, resulting in ETH borrow rates averaging 169 basis points higher than BTC in Q1.
Safety Module
In Q1, the weighted APR for depositors in Aave's Safety Module experienced a slight QoQ decline, decreasing from 10.1% to 8.7%. For stkABPT holders, the reduction was more pronounced, falling 2.8% due to a net inflow of 183 million ABPT. On the other hand, stkAAVE holders experienced a smaller 0.8% decline as the quarter saw a net inflow of 909,000 AAVE, reversing the net outflow of 734,000 in Q4.
Disbursements to Safety Module depositors are sourced from the Ecosystem Reserve, and at the current emission rate of 1,100 AAVE per day, these disbursements have a runway of ~3.3 years. By the close of the quarter, 3.3 million AAVE were staked in the Safety Module, amounting to 21% of the total supply.
Qualitative Analysis
GHO Initial Parameters
On March 3, Aave Companies released an analysis with recommendations for the genesis parameters of GHO. The recommendations included an initial borrow rate of 1- 2.5% to stay competitive with net stablecoin borrow rates across DeFi, which were found to be ~1%, including incentives. Additionally, a discount rate of 25% was recommended for AAVE stakers (stkAAVE holders) to further incentivize liquidity and reward community members for protecting the protocol via the safety module. However,the proposal also suggested capping the GHO supply minted by AAVE stakers at 25% in order to encourage decentralization among GHO holders.
As seen recently with USDC, even seemingly safe stablecoins have depeg risk in decentralized liquidity pools. The abovementioned analysis identified several key tools for safeguarding the GHO peg in the future, but it ultimately recommended a gated launch strategy. The strategy would include a capped supply that can be raised incrementally as liquidity milestones are achieved.
Finally, the analysis estimated first-year revenues by combining the recommendations, including a 1.5% or 2.5% interest rate, 25% stkAAVE discount, and 25% GHO minted at the discount target. In the 1.5% interest rate case, revenue estimates ranged from $2.5 million in the DAI growth scenario to $4.1 million in the FRAX growth scenario, while the 2.5% rate range from $4.2 million to $7 million.
On March 20, Aave service provider BDG Labs released a detailed outline introducing the third iteration of Aave Governance. The V3 governance model aims to improve on the current V2 system by reducing the cost of voting and streamlining the process. While maintaining its decentralization, V3 will introduce voting on Aave’s various deployments, which could potentially make it cheaper or even free for voters depending on the blockchain used for the proposal.
The new Aave Governance V3 system will heavily rely on two components: Aave Cross-Chain Infrastructure and Aave Robot. Aave Cross-Chain Infrastructure is a new cross-chain communication layer developed to improve and generalize the existing cross-chain governance system. This infrastructure reportedly enables bi-directional communication, allowing for seamless interactions between Ethereum and voting networks. It is also reported to support multiple bridges. As such, Aave would have more control over the selection and replacement of underlying bridges and could start to implement consensus rule customization.
Aave Robot, on the other hand, is an automation tool designed to handle permissionless actions within the Aave ecosystem. It was built on the proven Chainlink Automation technology. In V3, the Aave Robot will handle various permissionless actions, such as activating votes on the Ethereum core governance, settling data on the voting network from block hashes, and closing voting on the voting network. It will also be able to execute payloads and cancel proposals that don't fulfill proposition power requirements.
With a successful implementation, this new governance system will offer Aave community members a more efficient, cost-effective, and inclusive voting experience.
Closing Summary
Aave experienced positive growth in Q1 with the launch of its V3 market on Ethereum, accumulating over $1 billion in total value deposited. The outstanding loan balance on Arbitrum surged by 305%, primarily due to the ARB airdrop event. Despite daily active users (DAUs) declining by 34% across various platforms, Q1 DAUs still increased overall compared to previous quarters. Interest revenues increased slightly from heightened activity surrounding the USDC depeg event. The genesis parameters of GHO were proposed on March 3, aiming to ensure competitiveness and decentralization. Furthermore, the forthcoming Aave Governance V3 seeks to enhance the voting process by making it more efficient and inclusive for community members.
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Prior to joining Messari, Kentrell worked in real estate finance. After first diving into crypto in 2019, he became fascinated with DeFi in 2020, drawn to its data transparency, real-time settlement capabilities, and high yields. Today, Kentrell spends his time researching more sustainable yield strategies and writing about DeFi protocols at Messari.
Prior to joining Messari, Kentrell worked in real estate finance. After first diving into crypto in 2019, he became fascinated with DeFi in 2020, drawn to its data transparency, real-time settlement capabilities, and high yields. Today, Kentrell spends his time researching more sustainable yield strategies and writing about DeFi protocols at Messari.
