Aave: The core pillar of Decentralized Finance and on-chain economy, severely undervalued?

On-chain lending is one of the most important markets in the cryptocurrency industry, and Aave, as a leader in this market, has strong competitive barriers and user stickiness. We believe Aave's value is severely underestimated, and it has tremendous growth potential that the market has not yet fully recognized.

Aave launched on the Ethereum mainnet in January 2020, marking its 5th year of operation this year. Today, Aave has become the largest lending protocol, with a total active loan amount of $7.5 billion, which is five times that of the second place.

Protocol metrics continue to grow, surpassing the previous cycle peak.

Aave is one of the few DeFi protocols that have surpassed the levels of the 2021 bull market. For example, its quarterly revenue has exceeded the peak of the bull market in the fourth quarter of 2021. It is noteworthy that even during the market consolidation period from November 2022 to October 2023, Aave's revenue continued to accelerate. As the market warms up in the first and second quarters of 2024, Aave's momentum remains strong, with a month-on-month growth rate of 50-60%.

Since the beginning of the year, thanks to the increase in deposits and the rise in prices of underlying assets such as WBTC and ETH, Aave's total value locked (TVL) has nearly doubled, recovering to 51% of the peak value of the 2021 cycle. This indicates that Aave is more resilient compared to other leading Decentralized Finance protocols.

Strong profit performance reflects a high degree of alignment between the product and the market.

Aave's revenue peaked in the last cycle, coinciding with several smart contract platforms issuing a large amount of token incentives to attract users and liquidity. This brought about unsustainable speculative capital and leverage levels, amplifying the revenue figures of most protocols.

Currently, the token incentives of the main chain have been exhausted, and Aave's own token incentives have also dropped to negligible levels. This indicates that the metric growth over the past few months has been organic and sustainable, driven primarily by a recovery in market speculation activities, which have pushed up active lending and borrowing rates.

Moreover, even during periods of reduced speculative activity, Aave has demonstrated the ability to drive fundamental growth. Amidst the significant decline in the global risk asset market at the beginning of August, Aave's revenue remained strong, benefiting from successfully collecting liquidation fees during the loan repayment process. This proves that Aave has the capability to withstand market fluctuations across different collateral types and multi-chain environments.

Strong fundamental recovery, Aave's price-to-sales ratio remains at a three-year low.

Despite a strong recovery in indicators over the past few months, Aave's price-to-sales ratio is only 17 times, at its lowest level in three years, well below the median level of 62 times during the same period.

Aave is expected to strengthen its dominance in the Decentralized Finance lending space.

Aave's competitive advantages are mainly reflected in four points:

1. Protocol security management records are good: So far, Aave has not experienced any major smart contract-level security incidents. The good security record brought by strong risk management capabilities is often the primary consideration for DeFi users when choosing lending platforms, especially for whale users with large amounts of funds.

2. Network Effects: DeFi lending is a typical two-sided market. Depositors and borrowers constitute the supply and demand sides. Growth on one side drives growth on the other, making it increasingly difficult for newcomers to catch up. In addition, the more abundant the overall liquidity of the platform, the smoother the liquidity inflow and outflow for depositors and borrowers, which enhances the platform's attractiveness to large capital users and further stimulates the growth of the platform's business.

3. Effective DAO Governance: The Aave protocol has fully implemented a DAO-based governance model. Compared to centralized team management, DAO involves more comprehensive information disclosure and thorough community discussions. In addition, Aave's DAO community brings together a group of highly skilled governance professionals, such as top risk management service providers, market makers, third-party development teams, financial advisory teams, and more. This diverse participant structure enhances active governance participation on the platform.

4. Multi-chain Ecosystem Positioning: Aave has been deployed on almost all mainstream EVM L1/L2s, and its TVL remains leading on all deployed chains except for the BNB Chain. The upcoming Aave V4 version will enable cross-chain liquidity, further highlighting its cross-chain liquidity advantages.

Reform token economics to promote value accumulation and eliminate reduction risks

The Aave Chan Initiative (ACI) has just launched a proposal aimed at reforming the AAVE token economics, hoping to introduce a revenue-sharing mechanism to enhance the token's utility.

The first major shift is the elimination of the risk of AAVE being slashed when the security module is activated. Based on the brand-new Umbrella security module, stkAAVE and stkABPT will be replaced by stk aToken, with the first batches being aUSDC and awETH. aUSDC and awETH suppliers can choose to stake assets to earn additional fees on top of the interest paid by borrowers (including AAVE, GHO, and protocol income). These staked assets face the risk of slashing and destruction during shortage events.

In addition, the yield distribution mechanism will further enhance the demand for AAVE. The introduction of the Anti-GHO token, which is generated by stkAAVE holders who mint GHO. Users can claim Anti-GHO and have two ways to use it: burn Anti-GHO to mint GHO, which can be used for free debt repayment; or deposit GHO into the security module to earn stkGHO.

Aave will also allow the net excess protocol revenue to be redistributed to token stakers, but certain conditions must be met. As a result, the Aave protocol will launch a continuous eight-digit buyback program, which will increase in scale as the protocol continues to grow.

Aave is expected to achieve significant growth

Aave has multiple growth drivers in the future, and with its current advantageous position, it is expected to benefit from the long-term growth trend of cryptocurrency as an asset class. From a fundamental perspective, Aave has several revenue growth avenues:

Aave v4

Aave V4 will further enhance its competitiveness and help attract the next wave of one billion users to Decentralized Finance. By enabling seamless liquidity access across multiple networks, Aave will simplify the cross-chain lending process. The unified liquidity layer will also deeply integrate account abstraction and smart accounts, allowing users to manage positions of multiple isolated assets.

Aave also plans to explore the integration of products based on physical assets, which will be built around GHO, aiming to connect traditional finance with Decentralized Finance, attracting institutional investors and injecting a large amount of new capital into the Aave ecosystem.

is positively correlated with the growth of BTC and ETH as asset classes.

The launch of Bitcoin and Ethereum ETFs is an important milestone in the process of cryptocurrency adoption. These ETFs are expected to attract significant capital from both institutions and retail investors, further integrating digital assets into mainstream portfolios.

For Aave, the overall growth of the crypto market is a positive factor, as more than 75% of its asset composition consists of non-stable assets (mainly Bitcoin and Ethereum derivative assets). Therefore, Aave's TVL and revenue growth are directly related to the growth of these assets.

is linked to the growth of stablecoin supply

In the future, Aave is also expected to benefit from the growth of the stablecoin market. As the signals for global central banks entering a rate-cutting cycle become increasingly clear, the opportunity cost for investors seeking sources of yield will decrease. This may incentivize capital to flow out of traditional financial yield instruments and into stablecoin farming in the DeFi space for higher returns. Moreover, during bullish market conditions, investors' risk appetite increases, and risk-seeking behavior becomes more common, which will further stimulate stablecoin lending activities on platforms like Aave.

Summary

We are optimistic about the prospects of Aave as a leading player in the rapidly growing decentralized lending space. We believe that, with strong network effects and superior token liquidity and composability, Aave will continue to solidify and expand its market dominance. The upcoming tokenomics upgrade will further enhance the protocol's security and strengthen its value capture capability.

In recent years, the market has generalized all DeFi protocols and priced them as an asset class with limited growth potential. This phenomenon can be seen in the steady increase of Aave's TVL and revenue, while its valuation multiples have declined against the trend. We believe that this mismatch between valuation and fundamentals will not last long. AAVE currently offers an excellent risk-adjusted investment opportunity in the cryptocurrency industry.