The most significant update to one of DeFi’s leading players
Aave V3 is looking to remove entry barriers, improve the user experience and push DeFi into the mainstream. Since morphing from a peer-to-peer lending platform under the name of ETHLend, Aave has gone on to become a decentralized finance powerhouse that accounts for more than $22 billion of the total value locked (TVL) in DeFi today.
The Aave Protocol is a decentralized non-custodial liquidity protocol where users can participate as suppliers, borrowers, or liquidators. Suppliers provide liquidity to a market and can earn interest on the assets provided. At the same time, borrowers can borrow in an overcollateralized way and also engage in flash loans, which do not require over-collateralization. V3 allows users to optimize their assets supplied to Aave regarding yield generation and borrowing power.
Despite operating in a multichain environment on Avalanche and Polygon, core activities remained on the increasingly congested Ethereum network. As such, Aave has always been at the whim of the Ethereum blockchain and its ever-increasing gas fees. The introduction of V3 aims to solve this problem for users and Aave themselves. The team has focused its V3 upgrades on several critical areas, including capital efficiency, Layer-2 optimization, protocol safety, decentralization, and overall user experience.
The popularity and opportunities presented to protocols like Aave on Layer-2 networks are vast. However, one core problem is that the main transaction costs on Layer-2 come from calldata. Calldata is a unique data location that contains the function arguments. It is a non-modifiable, non-persistent area where function arguments are stored and behave mostly like memory. To minimize the cost, Aave V3 uses different Layer-2 contracts on Arbitrum and Optimism that condense the info passed to Pool methods.
Capital efficiency uses the least invested capital to drive the maximum equity return. Of course, this is every investor’s dream. Hence, we look at Aave’s improvements in this area early on. The primary goal for Aave V3 is to generate more yield for liquidity providers.
As mentioned, Aave has almost $22 billion locked away in its smart contracts, the majority of which sits idle, generating yield for liquidity providers from borrowing activity. The yield is secure and steady, but Aave felt they could make improvements. Introducing features that let users reuse idle capital without increasing solvency contingencies and without reallocating assets to other DeFi dapps reduces the reliance on asset bridges, reducing the overall smart contract risks.
Aave introduced Isolation Mode, a feature inspired by MakerDAO’s approach to exposure management. The feature now lets Aave governance members vote on which assets should be listed as isolated. Borrowers supplying an isolated asset as collateral can’t add other assets to their collateral and can only borrow a set basket of stablecoins subject to a debt ceiling.
The Portal feature allows the flow of liquidity between Aave V3 markets across different networks. The upgraded V3 enables governance-approved bridges to burn aTokens on the source network while instantly minting them on the destination network. The underlying assets can then be supplied to Aave on the destination network in a deferred manner, bypassing it to the pool after moving through a bridge. The addition of the portal feature enables supplied assets to flow between Aave iterations operating on different blockchains.
Bridges are a necessary feature but come with inherent risks that have already seen hundreds of millions of dollars stolen this year. The most notable cases of 2022 are the Wormhole and Ronin exploits. Bridges are seen as a weak link in the transactional process that, for a moment, leave tokens exposed to increased risks.
Aave’s introduction of governance-approved bridges puts Aave users at the heart of decision-making. Moreover, the portal feature required few changes as it leverages Aave’s interest-bearing aTokens to burn them on the source network while instantaneously minting them on the destination network.
Efficiency Mode (eMode)
The High Efficiency Mode, or eMode, allows borrowers to extract the highest borrowing power from their collateral when the supplied and borrowed assets are correlated in price, particularly when both are offshoots of the same underlying asset. Such as dollar-backed stablecoins pegged to USD.
Aave V3 brings more sophisticated parameters and features than the previous versions of Aave. Most importantly, Aave governance voters can now configure the borrow and supply caps of assets to control how much of each asset can be borrowed and supplied. Aave governance can also lower the borrowing power control of any asset down to 0% without impacting existing borrowers.
Additionally, Aave V3 introduces the ability for Aave governance to permit entities to update the risk parameters of the protocol without going through a governance vote for every change. These entities can be DAOs or automated agents, such as Gauntlet, which can build on top of the feature and react automatically in case of unexpected events.
The high throughput, scalability, and low cost of Layer-2 networks mean that most of the assets from Aave that started life on Ethereum are transferred to Layer-2. To mitigate some of the issues in Layer-2 networks, V3 introduced an advanced price oracle sentinel. The feature introduces a grace period for liquidations and disables borrowing under exact circumstances and is designed for Layer-2 to handle any downtime of the sequencer.
Finally, to round off a slew of innovative risk management upgrades, In V3, the liquidation mechanism has been improved to allow a position to be fully liquidated when it approaches insolvency. Previously only half of the position could be liquidated at any point.
Multiple Rewards and Claim
In Aave V2, Aave Governance activated liquidity mining rewards through a community proposal, and while the rate differs per asset, the rewards were all denominated in stkAave tokens.
Aave Protocol V3 now offers users the option to have multiple rewards per token, making it possible for an asset listing to enable additional incentive rewards denominated in their protocol tokens. V3 also allows users to claim rewards to another account and claim multiple types of rewards per asset in a single transaction, saving Aave users time and money.
Aave V3 in Summary
Those new to decentralized finance may be feeling more confused than at the start of this article. However, much of what is outlined for Aave V3 is nothing more than background operations implemented to increase the overall efficiency, safety, and useability. For the most part, a casual user of Aave will be getting a better service and need not worry too much about the finer details of V3. In a nutshell, users will get more yield, more security, and a better user experience.
Some of the features here are genuinely brilliant for those with a keener eye for details, especially how Aave will use its aTokens to deal with bridging assets across chains. Additionally, it’s interesting to see a powerhouse like Aave going all-in on Layer-2, focussing serious efforts there and arguably outlining the future of DeFi.
The above does not constitute investment advice. The information given here is purely for informational purposes only. Please exercise due diligence and do your research. The writer holds positions in various cryptocurrencies, including BTC, ETH, and RADAR.