OpenFi: Aave (updated)
In this post, I’ll be providing an update on the many new improvements and innovations on Aave since my last write up. Founded in 2017, Aave is the top lending protocol in DeFi by TVL. In my view, what sets Aave apart from others is that, Stani and the team have continued to innovate and push the boundaries for DeFi. Aave was the first to introduce flash loans and fixed rate lending at a massive scale. This year alone, the protocol has expanded multichain to Polygon and Avalanche, and initiated work on Aave Arc, a product for institutional finance. There’s so much that has happened. Let’s break it down.
Disclaimer: The following piece is simply a summary of my opinions and should not be construed as investment advice or regulatory analysis.
O: Opportunity - How large is the Total Addressable Market? Does the project disrupt an existing market, or does it create a new market?
Score: 5/5
Over the past year, Aave has seen exponential growth in liquidity. Aave’s expansion to Polygon and other blockchains to avoid high network fees on Ethereum helped boost the project’s market share. The platform currently boasts around $12.8 billion Total Value Locked (TVL) across Ethereum and Polygon compared to just under $3 billion in January 2021, the last time I analyzed Aave in an OpenFi post.
Aave originally launched as ETHLend in 2017. The platform has operated in the consumer lending space since. The global lending market is valued at an estimated $6.9 trillion as of 2021, and according to analysis by Transunion the total origination volume in traditional personal loans reached $148 Billion in 2020.
When looking at Aave's total addressable market, it’s important to look at the lending industry on a full spectrum beyond DeFi applications, given considerable fintech disruption in the space. Based on the success of these fintech applications, there’s an opportunity for Aave and DeFi to convert new users and gain market share with innovative, digital, and cost-effective lending markets. Aave’s plan to launch an institutional lending platform, Aave Arc, is a significant step toward widespread adoption. Aave has also obtained an electronic money license in the UK, positioning the company as a decentralized Neobank competing with the likes of Revolut who sports a valuation of $33 Billion. Aave is currently #2 in TVL amongst all DeFi protocols, right behind Curve.
P: Product - How innovative and differentiated is the product? Is there product-market fit? How easy is it to use the product (i.e. good user interface and experience)?
Score: 5/5
Aave fully migrated from V1 to V2 as of the end of January, and this update primarily focuses on bringing flexibility to their users. Users now have the option of lending and borrowing at fixed or variable interest rates based on their investment strategy and risk profile. Users can trade their assets deposited in Aave, creating a new market similar to a crypto bond market. Additionally, Aave now accepts liquidity provider (LP) tokens as collateral from certain Uniswap AMM pools, which allows individuals to simultaneously earn yield from Uniswap by collecting trading fees and use the Aave LP tokens as collateral to borrow other assets.
In the past several months, traditional asset management firms like hedge funds, family offices, and other institutions have reached out to Aave to get involved in DeFi. The main deterrent was the lack of KYC and AML processes. There was essentially no way to confirm that the funds borrowed in Aave were not used in a non-compliant manner. The same also goes for funds that institutions lend out. Aave Arc, the institutional lending platform mentioned above, addresses these concerns and allows traditional financial institutions to participate in the high yields within DeFi. Aave Arc is a permissioned liquidity pool for white listed individuals and entities that have gone through extensive KYC, KYB and AML processes via service partners, such as Fireblocks. Aave Arc is still subject to Aave governance from the entire Aave community. Arc will begin with the same service offering as Aave V2 but will start off by supporting a more limited number of assets, including Bitcoin, Ether, USDC, and the Aave token. Institutional capital is flowing into DeFi, and Aave Arc is another example of existing protocols opening the doors and implementing new tools that make platforms more compliant for both institutions and the DeFi natives.
E: Experience - Does the team have any previous experience building software and technology? Is the team well-versed in blockchain? What previous experience does the team have to ensure success?
Score: 4.5/5
Aave was founded by Stani Kulechov, Jordan Gustave and Ville Valkonen in 2017. Since inception, the founding team has become synonymous with the overall DeFi ecosystem and have established themselves as thought leaders in the space.
The core team has expanded since and now is distributed around the world. I will highlight a few of their new additions:
Ajit Tripathi, Head of Institutional Business at Aave previously worked at ConsenSys, PwC, Barclays, Goldman Sachs. He’s currently pioneering Aave Arc at the company.
Rebecca Rettig, General Counsel at Aave, has over 18 years in legal experience and with a JD from Columbia’s Law school and a Masters and Undergrad from London School of Economics and Stanford, respectively.
Peter Karr, CFO at Aave, has previous financial experience from Deutsche Bank, Royal Bank of Canada and HSBC along with CFO experience at a bank. .
Aave’s team has also added members who have worked at Venmo, Deloitte, Dharma, EY, and more.
N: Network Effects - Will more people in the network benefit when others join? Are there high switching costs and stickiness in using the platform?
Score: 3.5/5
Like other DeFi apps discussed here on OpenFi, Aave also benefits from network effects associated with composability. Open smart contract platforms allow decentralized applications to seamlessly interact with each other like “Money Legos”. A few different types of applications have integrated with Aave, creating new products for users and opportunities to do different types of transactions on one platform. These applications include yield rebalancers that work as automated asset managers, such as Stake Capital, Idle Finance, Staked Us, and Tool, Synthetix, a synthetic asset protocol, Opium Finance, an interest rate platform, and Barnbridge, a fixed income protocol. The more DeFi apps that integrate into Aave’s platform, the more Aave establishes itself in terms of stickiness and growth as it welcomes users from other applications and expands its offerings.
Aave has also expanded to Polygon while integrating Transak, a direct deposit service. Both of these collaborations have increased Aave’s reach. They also integrated with the Fintech firm, Taurus group, to allow for banks and exchanges to borrow digital assets, another example of Aave incorporating traditional financial products into its platform. With Aave Arc, the doors will soon be open for institutions to use Aave as a service and to integrate it into existing operations to expose their clients to crypto lending and borrowing.
F: Fundamentals: Do the underlying unit economics make sense within the current network? How quickly are users growing? How much value has been transacted or locked up?
Score: 4.5/5
According to TheBlock, Aave generated over $351 million in revenue over the last year, which is more than Uniswap. Additionally, the protocol has almost $7.4 billion in outstanding debt. A portion of the revenue generated goes to lenders, while the rest goes to the Aave treasury and can be utilized for growth strategies, rewards, programs, insurance, and other ways the Aave token holders see fit. Currently, their treasury has over $800 million in reserves with an average inflow of $2.26 million per month for this year.
Aave has grown exponentially from just under $3 Billion TVL as of the last OpenFi post on Aave to $11.63 Billion.
I: Incentives - Are there proper cryptoeconomic incentives in place for network stakeholders and users to support blitzscaling?
Score: 5/5
With the launch of Aave’s v2 platform, the AAVE token drives governance and staking. The token has a fixed supply of 16M AAVE with 3M AAVE reserved for ecosystem incentives. In short, AAVE token holders can stake their AAVE tokens into the security module, which allows users to earn more AAVE tokens (with a lockup period when redeeming) and fees generated from the AAVE protocol. Similar to other protocols, AAVE token holders directly vote on proposals to introduce new features and products to the protocol, encouraging proposals that will increase fees generated from the protocol and improve the platform in the long run. Aave also has an ecosystem treasury where governance token holders can utilize it to tweak incentives or maintain solvency in a Black Swan event. Aave has established a unique governance and token architecture to provide a robust connection between governance token holders, the money markets, the treasury, the safety module and liquidity providers, enabling Aave to become self-sustainable and more decentralized.
Due to Ethereum network congestion and high gas fees, blockchains with scaling capabilities, such as Polygon became popular with many major DeFi apps such as Curve, Sushi Swap, Beefy Finance, BzX, Chainlink, The Graph, and Aave. To incentivize users to move to Polygon and use the version of Aave on Polygon there was a $40 million rewards program that gave an extra yield in Polygon’s MATIC token every time a user lent or borrowed assets. The program drove Aave’s TVL on Polygon from $1.4 million to just under $2 billion in a matter of months. Aave has now expand to Avalanche with a $20 million user incentives package through the Avalanche Rush program. By working closely with network protocol teams and developing these incentive programs to bootstrap growth, Aave continues to solidify its place as frontrunner in all of DeFi.
Overall Score: 27.5/30
Hope you enjoyed my updated analysis on Aave. As you can see, Stani and the team have worked hard to build the protocol and have not stopped innovating along the way. It’s been great seeing them grow along with DeFi as a whole. I can’t wait to see how Aave does on Avalanche.