Interpreting Aave V4: A Transformation from Product to "Bank"

Original Title: "Interpreting Aave V4: A Transformation from Product to 'Bank'"

Original Author: Eric, Foresight News

On the evening of March 30, Beijing time, the Aave V4 version, which was initiated in 2024, officially launched on the mainnet, bringing the first good news since the Aave DAO governance debate.

The V4 version can be said to be a complete overhaul of Aave, with the core change being the integration of originally independent lending markets into a unified liquidity pool structure: Hub and Spoke.

In the V4 version, there is a unified liquidity center (the Hub) on each chain or L2, where all user-deposited assets for lending will be stored in a single liquidity pool. The Hub is responsible for global coordination, credit limit control, system-level constraints (such as "total borrowing ≤ total supply"), and emergency pauses. The Hub does not directly face users but manages liquidity centrally in the background.

It is worth noting that there is not just one Hub on each chain, but different Hubs are designed based on different needs, which essentially serves as a form of risk isolation. For example, V4 has currently launched Core Hub, Prime Hub, and Plus Hub. The Core Hub includes mainstream assets and is available to all users, while the Prime Hub is designed for suppliers seeking more "controllable" collateral. The Plus Hub is designed for strategy-based stablecoins, with its parameter design needing to consider the scale of the project.

As for the Spoke, you can understand it as an independent market, where each market has its own lending functions, risk parameters, and collateral rules. Within a Hub, users' assets exist in the same liquidity pool, and borrowers need to select different Spokes based on their needs. For example, as shown in the image, users can deposit WETH as a borrowable asset, and borrowers can borrow WETH in the first four Spokes, but only the EtherFi Spoke can use weETH as collateral.

Although the official statement is that it can integrate fragmented liquidity, in practice, there is not much difference for users borrowing against high-quality collateral. For instance, if you want to use ETH as collateral to borrow assets, the operations in V3 and V4 are not different, as long as you can ensure that the health factor does not drop too low.

So, in terms of liquidity integration, V4 is indeed more refined than managing independent markets, but it cannot be said to be a qualitative leap; the real difference comes from the customized parameters of Spokes and the new liquidation engine.

In V4, the borrower's interest rate depends on the base rate and risk premium. The base rate still uses the utilization curve as in V3, which rises slowly below the optimal utilization rate and steeply rises above it. The risk premium depends on the nature of the collateral; if the collateral is more stable assets like USDT, ETH, or WBTC, the risk premium will be very small or even zero, while high-risk altcoins will have a high risk premium to avoid the situation where "good assets subsidize bad assets."

For a simple example, in V3, the interest rate is entirely dependent on supply and demand. Similarly, when lending USDT, although there may be differences in borrowing limits (LTV) and liquidation thresholds, the interest rates for collateralizing ETH and LINK are the same under the same supply and demand conditions, but obviously, LINK is more volatile than ETH. If the interest rates are the same, borrowers collateralizing LINK will raise the utilization rate, leading to the problem where the borrowing cost for users collateralizing ETH does not decrease but instead increases.

V4 optimizes this flaw, requiring users borrowing against high-risk assets to pay higher costs, while users providing funds can also earn higher returns. At the same time, higher interest rates limit borrowing demand, making the cost advantage for users borrowing against high-quality assets more apparent.

In terms of the liquidation mechanism, liquidators will only restore the health factor to the preset target value of the Spoke, and the lower the health factor, the higher the liquidation bonus. This design not only gives borrowers greater operational space but also reduces the overall bad debt risk of the platform. Additionally, the new liquidation engine has introduced a "dust prevention mechanism," meaning that when the remaining debt or collateral falls below a threshold (e.g., $1,000), the liquidator must fully liquidate the position to prevent small residuals from accumulating and reducing capital efficiency.

Finally, idle liquidity in the Hub can be automatically invested in low-risk yield strategies approved by governance (such as short-term government bonds, stablecoin LPs, money market instruments, etc.), which increases the income for capital suppliers while also boosting the DAO's revenue, which may be one of the few advantages of "unified liquidity."

Overall, the advantages brought by Aave V4's unified liquidity in lending are not significant, and the so-called composability, where borrowing users can manage positions across different Spokes, is not much more convenient than in V3. But as the author mentioned in the title, V4 has transformed Aave from a product into a financial infrastructure similar to a "bank."

Setting aside various complex businesses, the core business of a bank is to absorb deposits, leaving a portion for reserves to meet users' daily payment and transfer needs, and then earning the interest spread through lending. As for idle funds, banks can also allocate different investments within the limits of their risk tolerance.

Headquarters of St. George's Bank, St. George's Palace

Founded in 1407 in Genoa, Italy, St. George's Bank is often considered the world's earliest bank. The bank not only provided deposit and loan services but also handled government debt management, currency exchange, and fund transfers, meeting the commercial needs of Genoa as an important trade center in Europe at that time.

From the launch of ETHLend in 2017 to the launch of Aave V4 in 2026, in less than 10 years, Aave has taken on the appearance of an original bank. Of course, there are significant differences between Aave and banks; this is merely an analogy. Compared to P2P, the banking model, which has endured countless black swan events over hundreds of years, is naturally a better choice, just as V4 is to V3.

If you observe closely, you will find that a large number of "innovations" in the DeFi space have almost turned into the dust of history, such as the hot DeFi 2.0 in the second half of 2021. Instead, projects like Aave, which have simple operations and logic that has matured in traditional finance for hundreds of years, have survived and thrived. After years of exploration, many DeFi projects have likely discovered this issue: the ceiling for DeFi is very high, but every step taken in traditional finance cannot be omitted.

Aave V4 concentrates liquidity, and there are many things that can be done in the future, such as using assets that have been idle for a certain period (e.g., over a year) for relatively higher-risk investments, such as providing ETH/USDT LP on Uniswap, operating entirely in the manner of a commercial bank, and gradually increasing other business operations of a commercial bank, such as credit cards (referencing Ethfi's model of consuming stablecoins through collateralized lending) and so on.

Furthermore, Aave could expand into "investment banking." For example, launching an ICO platform that allows users who deposit assets to earn interest while borrowing USDT or USDC to participate in investments, without needing to withdraw assets to sell for stablecoins to participate in the ICO, thus charging fees to projects while also earning interest.

Although the Hub & Spoke mechanism does not bring significant innovation to lending itself, it lays the most important groundwork for the next steps.