DeFiance Capital founder: Aave is seriously undervalued and has huge growth potential

Original author: Arthur, founder of DeFiance Capital

Original translation: Wang Eryu, PANews

On-chain lending is one of the most important markets in the crypto industry, and as the undisputed leader in this market, Aave has extremely strong competitive barriers and user stickiness. We believe that Aave's value is seriously underestimated and it has huge growth potential, which the market has not yet recognized.

In January 2020, Aave landed on the Ethereum mainnet, and this year marks its fifth year online. Today, Aave is the largest lending protocol, with a total active loan amount of US$7.5 billion, which is 5 times that of the second-ranked Spark.

(Data as of August 5, 2024)

Protocol Metrics Continue to Grow, Surpassing Previous Cycle Highs

Aave is also one of the few DeFi protocols with metrics surpassing the 2021 bull run. For example, its quarterly revenue has surpassed the peak of the bull run in Q4 2021. What is particularly striking is that even during the market consolidation period from November 2022 to October 2023, Aave's revenue growth accelerated. As the market picks up in Q1 and Q2 2024, Aave continues to gain momentum, with a month-on-month growth rate of 50-60%.

(Source: Token Terminal)

Since the beginning of the year, Aave's TVL (total locked value) has almost doubled, recovering to 51% of the 2021 cycle peak, thanks to increased deposits and rising prices of underlying assets such as WBTC and ETH. This shows that Aave is more resilient than other top DeFi protocols.

Data as of August 5, 2024

Strong profitability reflects a high degree of product-market fit

Aave’s revenue peaked in the last cycle, coinciding with the massive issuance of token incentives by multiple smart contract platforms such as Polygon, Avalanche, and Fantom to attract users and liquidity. This led to unsustainable levels of speculative capital and leverage, amplifying the revenue figures of most protocols.

Today, the main chain’s token incentives have dried up, and Aave’s own token incentives have fallen to negligible levels.

(Source: Token Terminal)

This suggests that the metric’s growth over the past few months is organic and sustainable, with the core driver being the return of market speculation, which has pushed up active lending and borrowing rates.

In addition, Aave has demonstrated its ability to drive fundamental growth even during periods of subdued speculative activity. Aave's revenue remained strong as global risk asset markets plunged in early August, thanks to its successful collection of liquidation fees during loan repayments. This proves Aave's ability to withstand market volatility in a multi-chain environment with different collaterals.

(Data as of August 5 Source: TokenLogic)

Despite a strong recovery in fundamentals, Aave's price-to-sales ratio is still at its lowest level in three years

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

(Source: Coingecko, Token Terminal)

Aave is expected to strengthen its dominance in the field of decentralized lending

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

· Good record of protocol security management:Most new lending protocols will encounter security issues in the early stages of operation. So far, Aave has not had a major smart contract-level security incident. A good security record brought by strong risk management capabilities is often the first consideration for DeFi users when choosing a lending platform, especially for whale users with large amounts of funds.

· Bilateral network effect:DeFi lending is a typical bilateral market. Depositors and borrowers constitute both sides of supply and demand. The growth of one side will drive the growth of the other side, and it will become increasingly difficult for latecomers to catch up. In addition, the more abundant the overall liquidity of the platform, the smoother the liquidity in and out of depositors and borrowers, and the more attractive the platform is to users with large amounts of funds, which can stimulate further growth of the platform's business.

· DAO management:The Aave protocol has fully implemented a DAO-based management model. Compared with the centralized team management model, DAO involves more comprehensive information disclosure and more thorough community discussions. In addition, Aave's DAO community brings together a group of professional institutions with high governance levels, such as top risk management service providers, market makers, third-party development teams, financial advisory teams, etc. This diversified participant structure brings active governance participation to the platform.

· Multi-chain ecological positioning:Aave has been deployed on almost all mainstream EVM L1/L2, and TVL remains the leader on all deployment chains except BNB Chain. The upcoming Aave V4 version will open up cross-chain liquidity, further demonstrating its cross-chain liquidity advantage. See the figure below for details:

(Data as of August 5 Source: DeFiLlama)

Reform token economics, promote value accumulation, and eliminate slashing risks

The Aave Chan Initiative (ACI) has just launched a proposal to reform the AAVE token economics, hoping to introduce a revenue sharing mechanism to enhance the utility of the token.

The first major shift is to eliminate the risk of AAVE being slashed when the security module is mobilized.

● Currently, stakers of AAVE tokens (stkAAVE - $228M TVL) and AAVE/ETH Balancer LP tokens (stkABPT - $99M TVL) in the Security Module are at risk of having their tokens slashed - to cover a shortfall event.

● However, due to the lack of correlation between stkAAVE and stkABPT and collateral assets that have accumulated bad debts, they are not ideal coverage assets. In such an event, selling pressure on AAVE would in turn reduce the level of coverage.

● Based on the new Umbrella security module, stkAAVE and stkABPT will be replaced by stk aTokens, the first to be aUSDC and awETH. aUSDC and awETH suppliers can choose collateral assets to earn additional fees (including AAVE, GHO and protocol revenue) on top of the interest paid by borrowers. These collateral assets are at risk of slashing and destruction in a shortage event.

● This arrangement will benefit both platform users and AAVE holders.

In addition, the revenue sharing mechanism will further increase demand for AAVE.

● Introducing Anti-GHO

○ Currently, stkAAVE users enjoy a 3% discount when minting and borrowing GHO.

This will be replaced by a new “anti-GHO” token generated by stkAAVE holders who mint GHO. Its generation is linear and proportional to the interest accumulated by all GHO borrowers.

○ Users can claim anti-GHO and use it in two ways:

■ Burn Anti-GHO to mint GHO, which can be used to repay debt for free

■ Deposit GHO security module to obtain stkGHO

○ This strengthens the alignment of interests between AAVE stakers and GHO borrowers and will be the first step in a broad revenue sharing strategy.

● Burn and Distribution Plan

○ Aave will allow redistribution of net excess protocol revenue to token stakers, subject to the following conditions:

■ Aave Collector net holdings equal to two annual service provider recurring costs in the last 30 days.

■ Aave Protocol’s 90-day annualized revenue reaches 150% of all protocol expenses (including AAVE acquisition budget and aWETH aUSDC Umbrella budget) year-to-date.

With this, the Aave Protocol will begin an ongoing 8-figure buyback program, which will increase in size as the protocol continues to grow.

In addition, AAVE's circulation is almost fully diluted, and there will be no large-scale supply unlocking in the future. In sharp contrast, some recent token issuances have experienced serious value loss during the token generation event (TGE) phase due to low circulation and high fully diluted valuation (FDV).

Aave is poised for significant growth

Aave has multiple growth drivers ahead of it and is expected to benefit from the long-term growth trend of cryptocurrencies as an asset class given its current strong position. From a fundamental perspective, Aave has multiple avenues for revenue growth:

Aave v4

Aave V4 will further enhance its competitiveness and help it attract the next billion users to DeFi. First, Aave will focus on revolutionizing the DeFi interaction experience by building a unified liquidity layer. Aave will simplify the cross-chain lending process by enabling seamless access to liquidity across multiple networks (including EVM and eventually non-EVM). The unified liquidity layer will also deeply integrate Account Abstraction and Smart Accounts, allowing users to manage positions on multiple isolated assets.

Second, Aave will increase the accessibility of the platform by expanding to more chains and introducing more asset classes. In June, the Aave community voted in favor of deploying the protocol on zkSync. This is the 13th blockchain network that Aave has landed on. Then in July, the Aptos Foundation issued a proposal to deploy Aave on Aptos. If approved, this will be Aave's first entry into a non-EVM network, which will further consolidate its position as a true multi-chain DeFi giant. In addition, Aave also plans to explore the integration of RWA-based products, which will be built around GHO and are expected to connect traditional finance with DeFi, attract institutional investors, and inject a large amount of new capital into the Aave ecosystem.

These developments ultimately gave birth to the Aave Network, which will become the core hub for stakeholders to interact with the Aave protocol. GHO will be used to pay fees, and AAVE will serve as the main staking asset for decentralized validators. Given that the Aave Network will be developed as an L1 or L2 network, we expect the market to revalue its tokens to reflect the value of this new infrastructure layer.

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

This year, the debut of Bitcoin and Ethereum ETFs was an important watershed in the popularization of cryptocurrencies, providing investors with a traditional and regulated tool to easily gain exposure to digital assets and avoid the complexity associated with directly holding these assets. By lowering the barrier to participation, these ETFs are expected to attract a large amount of capital from institutions and retail investors, driving digital assets further into mainstream portfolios.

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

Growth is linked to stablecoin supply

In the future, Aave is also expected to benefit from the growth of the stablecoin market. As the global central bank signals that it is entering a rate cut cycle, the opportunity cost for investors to find sources of income will decrease. This may encourage capital to flow out of traditional financial income instruments and turn to stablecoin farming in the DeFi field to obtain higher returns. In addition, in a bull market, investors' risk appetite increases and risk-seeking behavior becomes more common, which will further stimulate stablecoin lending activities on platforms such as Aave.

Summary

To reiterate, we are optimistic about the prospects of Aave, a leader in the continued growth of the decentralized lending field. We further elaborate on the core elements that will drive its future growth and analyze how each element can be further expanded.

We also believe that Aave will continue to consolidate and expand its market dominance with strong network effects and excellent token liquidity and composability. The upcoming token economics upgrade will further improve the security of the protocol and enhance its value capture capabilities.

In recent years, the market has lumped all DeFi protocols together and priced them as asset classes with limited growth potential. This phenomenon is reflected in the steady increase in Aave's TVL and revenue while the valuation multiples have fallen against the trend. We believe that this mismatch between valuation and fundamentals will not last long. AAVE currently provides a good risk-adjusted investment opportunity in the crypto industry.

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