Exploring the AAVE V4 Upgrade: Reshaping Lending with Modularity, Will the Veteran Coin See Another Bull Run?

Original Article Title: "Explaining AAVE V4 Upgrade: Reshaping Lending with Modularity, Can the Old Coin See a Revival?"

Original Article Author: San, Deep Tide TechFlow

On the evening of the 25th, AAVE founder Stani's announcement of the upcoming AAVE V4 launch post quickly attracted a lot of attention and discussion, while the recent AAVE and WLFI controversy over the 7% token allocation proposal has also caused a stir in the market.

At one point, the market's attention was all focused on AAVE, this veteran lending protocol.

Although the AAVE and WLFI controversy has not yet reached a final conclusion, behind this "drama," it seems to have revealed a different kind of scene— "flowing new coins, solid AAVE."

With the emergence of more and more new coins and the stimulation of on-chain fixed-token lending demand, AAVE undoubtedly has a strong fundamental and catalyst.

This V4 update may allow us to see its strong competitiveness in the DeFi field in the future and the root cause of its continuously increasing business volume.

From Lending Protocol to DeFi Infrastructure

When we discuss AAVE V4, we first need to understand a key question—why is the market looking forward to this upgrade?

From the 2017 ETHLend to today's $386 billion TVL DeFi giant, as a veteran protocol, each past version update of AAVE has actually been optimizing and has been able to affect on-chain asset liquidity and gameplay to varying degrees.

AAVE's version history is, in fact, the evolutionary history of DeFi lending.

In early 2020, when V1 was launched, the total DeFi locked value was less than $10 billion. AAVE used liquidity pools instead of a P2P model, transforming lending from "matchmaking waiting" to "instant settlement." This change helped AAVE quickly gain market share.

V2 was launched at the end of 2020, with the core innovation being flash loans and debt tokenization. Flash loans gave rise to arbitrage and liquidation ecosystems, becoming a significant source of protocol revenue. Debt tokenization allowed positions to be transferred, paving the way for subsequent yield aggregators. V3 in 2022 focused on cross-chain interoperability, allowing more on-chain assets to enter AAVE and becoming a connector for multi-chain liquidity.

More importantly, AAVE has become a pricing benchmark. When designing interest rates for DeFi protocols, reference is made to AAVE's supply-demand curve. When new projects choose collateral ratios, they also benchmark AAVE's parameters.

However, despite being infrastructure, the limitations of the V3 architecture are becoming increasingly apparent.

The biggest issue is liquidity fragmentation. Currently, AAVE has a $600 billion TVL on Ethereum, while Arbitrum has only $44 billion, and Base even less. Each chain is a separate kingdom, and funds cannot flow efficiently. This not only reduces capital efficiency but also restricts the development of smaller chains.

The second issue is an innovation bottleneck. Any new feature requires going through a full governance process, from proposal to implementation often taking months. In the rapidly iterating environment of DeFi, this speed clearly cannot keep up with market demand.

The third issue is the inability to meet customized demands. RWA projects require KYC, GameFi requires NFT collateral, institutions require isolated pools. However, the unified architecture of V3 makes it difficult to meet these differentiated demands. It's either all or nothing — there's no middle ground.

This is the core issue that V4 aims to address: how to transform AAVE from a powerful yet rigid product into a flexible and open platform.

V4 Upgrade

According to publicly available information, the core improvement direction of V4 is to introduce a "Unified Liquidity Layer," adopting a Hub-Spoke model to change existing technical designs and even business models.

Image Source @Eli5DeFi

Hub-Spoke: Solving the Tradeoff Challenge

Simply put, the Hub aggregates all liquidity, while the Spoke handles specific businesses. Users always interact through the Spoke, and each Spoke can have its own rules and risk parameters.

What does this mean? It means that AAVE no longer needs to use one set of rules to serve everyone but can instead allow different Spokes to serve different needs.

For example, Frax Finance could create a dedicated Spoke that only accepts frxETH and FRAX as collateral, with more aggressive parameters. At the same time, an "Institutional Spoke" might only accept BTC and ETH, require KYC, but offer lower rates.

Two Spokes share the same Hub's liquidity, but are risk-isolated from each other.

The elegance of this architecture lies in its ability to solve the "both-and" dilemma. It aims to achieve both deep liquidity and risk isolation; unified management and flexible customization. In the past, these were contradictory in AAVE, but the Hub-Spoke model allows them to coexist.

Dynamic Risk Premium Mechanism

In addition to the Hub-Spoke architecture, V4 also introduces a dynamic risk premium mechanism, revolutionizing the way lending rates are set.

Unlike V3's uniform rate model, V4 adjusts rates dynamically based on collateral quality and market liquidity. For example, high-liquidity assets like WETH enjoy a base rate, while more volatile assets like LINK must pay an additional premium. This mechanism is automatically executed by smart contracts, enhancing not only the protocol's security but also making the cost of borrowing more equitable.

Smart Account

V4's smart account feature makes user operations more efficient. In the past, users needed to switch wallets between different chains or markets, making managing complex positions time-consuming and laborious. Now, smart accounts allow users to manage multi-chain assets and lending strategies through a single wallet, reducing operational steps.

A user can adjust their Ethereum-based WETH collateral and borrowing on Aptos within the same interface without manually transferring assets across chains. This simplified experience enables both small-scale users and professional traders to participate more easily in DeFi.

Cross-chain and RWA: Expanding DeFi Boundaries

V4 achieves instant cross-chain interaction through Chainlink CCIP, supporting non-EVM chains like Aptos, enabling more assets to seamlessly access AAVE. For example, a user can collateralize assets on Polygon and borrow on Arbitrum, all in one transaction. Moreover, V4 integrates real-world assets (RWA), such as tokenized government bonds, creating a new path for institutional funds to enter DeFi. This not only expands AAVE's asset coverage but also makes the lending market more inclusive.

Market Response

While AAVE experienced a sharp drop this week following the overall crypto market, its rebound today was significantly stronger than other leading DeFi tokens.

AAVE's token witnessed a 24-hour total network trading volume of $18.72 million after experiencing a crypto market crash this week, far surpassing Uni's $7.2 million and Ldo's $3.65 million, reflecting investors' positive response to the protocol's innovation, and the increased trading activity further enhanced liquidity.

The TVL metric more intuitively reflects the market's recognition. Compared to early August, AAVE's TVL has surged by 19% to nearly reach the $70 billion mark, hitting a new all-time high this month, currently ranking first in TVL on the ETH chain. This growth far exceeds the DeFi market's average level. The increase in TVL also validates the effectiveness of AAVE V4's multi-asset support strategy from another perspective, perhaps indicating that institutional funds have silently entered the scene.

According to TokenLogic data, AAVE's net asset value has reached a new high of $13.27 billion (excluding AAVE token holdings), growing by approximately 130% over the past year.

Regarding on-chain data, as of August 24, outstanding contracts on AAVE exceeded $430 million, hitting a new six-month high.

In addition to tangible data, AAVE's upgrade this time has also sparked widespread community discussion. Currently, the preliminary information released by V4 has received a lot of support and recognition, especially in the areas of fund utilization rate and composable DeFi, allowing the market to see more possibilities and potential.

Make DeFi great again

Combining the currently disclosed updates, it seems that AAVE's upgrade this time is likely to lead the DeFi market to the next level. Highlights of this upgrade like modular architecture, cross-chain expansion, and RWA integration have not only ignited market enthusiasm but also driven price and TVL increases.

And its founder, Stani, seems confident in the impact of the V4 upgrade on the DeFi track.

Perhaps, in the near future, AAVE will ride the liquidity "tailwind" brought by the arrival of the crypto bull market, heading straight to the top, opening up infinite possibilities.