Detailed Explanation of Aave V4: How the Lending Leader Builds a Defensive Moat Again?

Written by: Matt, Researcher at Castle Labs

Compiled by: Tim, PANews

At the Ethereum Community Conference (ETHCC), Aave founder Stani announced the upcoming release of the new version of the protocol, Aave V4. As the largest lending protocol in the DeFi space, this iteration has attracted significant market attention.

Today, I will focus on the functional updates of the Aave V4 protocol, particularly how the new interest rate parameters and the GHO stablecoin upgrade are reconstructing the protocol ecosystem. These innovative measures could profoundly change the capital efficiency model; with liquidity pools adopting a dynamic interest rate mechanism, borrowing rates will for the first time achieve market-driven pricing. Moreover, GHO's cross-chain enhancement module will not only improve the utility of the stablecoin but also optimize on-chain liquidation of debt positions, establishing a new financial infrastructure for the entire protocol.

What is AAVE V4?

Aave's total locked value has surpassed the $25 billion mark for the first time, becoming the first lending protocol in the DeFi space to achieve this milestone. Its development team is actively advancing the development of new features, aiming to further drive platform growth through adjustments in risk parameters.

The new features announced last year are about to go live:

Unified Liquidity Layer: Introduces a series of modules to lift the original restrictions on liquidity migration, while adding new features such as cross-chain lending.

Fuzzy control interest rate: This mechanism automatically adjusts the interest rate curve and inflection points based on market conditions, rather than relying on governance votes.

Liquidity premium: Borrowing costs will increasingly depend on the liquidity conditions of each token. Assets like ETH remain without a premium, serving as the benchmark currency, while other assets such as WBTC and wstETH will adopt corresponding premium mechanisms based on their liquidity conditions.

Aave V4 Lending Module: The team is exploring the adoption of smart accounts to support features such as the Aave Vault, which can lock liquidity, disable collateral functions, etc.

Dynamic risk allocation: The collateral ratio is linked to the market conditions at the time of establishing the position, rather than subsequent market fluctuations, providing greater stability for users' positions.

Automated asset delisting

Automated Fund Management

Clearing Engine V4: Aave's liquidation mechanism is undergoing a major upgrade, including variable liquidation parameters and reward mechanisms, while also supporting batch liquidation functionality.

Deeper GHO Integration: GHO will achieve a deeper native integration in Aave V4, including upgrades to the soft liquidation mechanism, paying stablecoin interest with GHO, and the addition of an emergency redemption mechanism among other optimizations.

The additional upgrades include features such as gas fee optimization, decommissioned tokenized positions, and stable interest rates.

Now let's delve into two major changes: the unified liquidity layer and the GHO upgrade.

Unified Liquidity Layer

The Unified Liquidity Layer has launched a brand new chain-agnostic, independent, and abstract liquidity infrastructure.

A significant improvement of this modular system is that new lending modules can be deployed or old lending modules can be taken offline without the need to migrate liquidity.

This architecture supports the addition or optimization of lending functions (such as isolated liquidity pools, physical asset modules, and collateral debt positions) without changing the overall system and clearing module. At the same time, it effectively addresses the liquidity fragmentation issues present in earlier versions of the protocol.

The liquidity layer supports both user-provided assets and natively minted assets, thereby improving integration with GHO and other cryptocurrencies that are collateralized by native assets of the Aave protocol.

Cross-chain lending may be one of the most influential functional modules, allowing users to deposit on one chain and borrow on another. This not only significantly enhances the platform's cross-chain liquidity potential but also creates new opportunities for market growth.

GHO Upgrade

GHO is an over-collateralized stablecoin launched by Aave, with a market value of over $220 million, and has increased by 53% since the beginning of 2025.

In addition to minor improvements such as enhancing the efficiency of native minting, the most noteworthy upgrade is the introduction of the flexible clearing mechanism. This mechanism draws on the innovative model of crvUSD, streamlining the clearing process through automated lending and clearing market makers (LLAMM).

The liquidation operation is carried out within a customizable range, and this mechanism guides the system to convert assets into GHO when the market declines and to repurchase collateral when it rises. Compared to crvUSD, Aave V4 has three major advantages: users can independently choose collateral for liquidation positions from the asset basket; they can freely select collateral for repurchase from all available assets on the Aave platform (including assets that were not initially provided); and they can also enjoy the benefits of automatic interest income generated from GHO.

Another notable change is that users in the stablecoin market can receive interest payments in the form of GHO, a mechanism that can expand the supply of GHO by directly converting interest into tokens.

Aave V4 introduces an emergency redemption mechanism to address extreme situations of severe and persistent depegging of GHO. Once this mechanism is triggered, the platform will gradually convert the collateral assets with the lowest health factor into GHO tokens based on the innovative LLAMM design, in order to repay user debts.

Conclusion

For a protocol as large and critically important as Aave, minimizing risk is essential, especially when launching major features such as cross-chain lending.

Automating processes such as asset delisting and interest rate model adjustments helps reduce reliance on slow DAO processes, especially when responding to market-driven changes.

Aave is confident in the growth of its stablecoin GHO, which has currently seen significant improvements and has achieved deeper integration within the protocol.

In the foreseeable future, Aave is expected to continue to maintain its cornerstone position in the DeFi space. The success of the broader ecosystem heavily relies on its ongoing leadership. After all, no other project can accumulate a total locked value at this level while maintaining an equivalent level of security.