AAVE founder issues warning: DeFi must never become an exit liquidity for Wall Street private equity lending

Original author: Stani.eth

Original compilation: Ken, ChainCatcher

Private credit is currently in a peculiar position.

The economy and funding costs are closely linked. Low interest rates mean borrowing is cheap, which theoretically should lead to higher utilization of credit instruments. Conversely, high interest rates mean borrowing is expensive, which should reduce demand for credit.

Since the Federal Reserve began an aggressive tightening cycle in March 2022, we’ve been living in a high-interest-rate environment: by mid-2023, rates soared from near zero to over 5%, marking the fastest rate hike cycle in four decades. As of early 2026, rates remain high with only slight cuts. For many consumers and businesses that started borrowing during low or moderate rates and still carry debt, this means significantly higher funding costs, which will only intensify over time.

All of this sounds normal. From growth to maturity, financing is almost a constant throughout a company’s lifecycle. But the problem arises when capital costs stay high for an extended period, creating unaffordable expenses for borrowers.

Typically, companies borrow from banks or other financial institutions, or via private credit from asset management firms.

How do private credit funds operate?

Private credit funds are usually closed-end or semi-liquid investment vehicles managed by asset managers. This structure makes sense: the fund needs to deploy capital into lending opportunities to generate returns. The investor base for private credit is broad, ranging from pension funds, insurance companies, and family offices to an increasing number of retail investors.

Closed-end funds do not allow redemptions before maturity (usually 7 to 10 years). Semi-liquid funds offer quarterly redemption windows with limits. Public Business Development Companies (BDCs), traded daily on exchanges, provide liquidity.

Essentially, private credit funds function like private banks: they lend to companies and collect interest.

What sectors do private credit fund?

Private credit typically finances leveraged buyouts in private equity, loans to mid-sized companies that cannot access the public bond markets, asset-backed loans (such as aircraft, shipping, and consumer loans), and real estate lending.

These funds often fill the financing gaps left after banks exit. This shift has been driven mainly by post-2008 regulations (notably Basel III), which forced banks to exit riskier corporate lending. Today, it’s estimated that 80-90% of leveraged buyouts in the U.S. middle market are financed by private credit.

Who are the main players?

• Apollo ~$460B AUM

• Blackstone ~$330B AUM

• Ares ~$280B AUM

• KKR ~$220B AUM

• Carlyle ~$190B AUM

• Blue Owl ~$170B AUM

What is the current situation?

Recently, the private credit sector has shown signs of distress. High interest rates continue to impose high capital costs, and AI is reshaping perceptions of many software companies financed by private credit, adding uncertainty about the future for these borrowers.

Markets are already repricing private credit:

• VanEck BDC Income ETF: down about 15% over the past year

• Blue Owl Capital: down roughly 50% over the past year, with about 30% of that decline occurring within 2026

• Apollo, Blackstone, Ares, KKR: down about 20% due to concerns over private credit

Currently, the average trading price of BDCs is about 20% below their net asset value (NAV), offering yields of 10-11%. This signals that loan portfolios may be overvalued, default rates could rise, or liquidity risks are building. More worryingly, historically, these funds have traded at premiums.

Some monitored loan default indicators have risen as high as 9%. Blackstone’s flagship private credit fund, BCRED, is a notable example.

BCRED recently limited redemptions. The fund’s assets are around $82 billion, and in Q1 2026, redemption requests hit $3.7 billion, about 8% of NAV. Blackstone injected $400 million of its own capital to support liquidity. Technically, the fund isn’t fully gated, but it’s very close.

Meanwhile, BlackRock’s $26 billion HPS Business Loan Fund (HLEND) received $1.2 billion in redemption requests, reaching a point where redemptions had to be frozen. About $580 million of redemption requests couldn’t be fulfilled.

Blue Owl’s retail private credit products faced $2.9 billion in redemptions in Q4 2025, representing 15% of NAV, mainly due to exposure to the software industry.

Can the market withstand private credit fund defaults?

Despite redemptions exceeding $7 billion (about 5-10% of NAV), and listed alternative asset managers’ stock prices falling 20-30%, the entire private credit market remains sizable—around $1.8 trillion to $2 trillion. Even the largest funds top out at $20-80 billion, compared to the $130 trillion global bond market and $180 trillion in bank assets. A single fund default is unlikely to trigger a broader market collapse or contagion. Moreover, large funds hold diversified portfolios of hundreds of loans, and semi-liquid or closed structures naturally lock in investor capital, providing a buffer against bank-like runs.

I’ve modeled three escalating scenarios:

• Scenario A: A major fund defaults (~$50 billion). Investors lose money, some companies lose financing, credit spreads widen. The financial system can likely absorb this shock.

• Scenario B: Multiple funds fail simultaneously. Credit markets freeze, highly leveraged companies can’t refinance, leading to a chain of defaults. This could trigger a credit cycle recession.

• Scenario C: Collapse of private credit + leveraged loans. A broader corporate credit crisis ensues: private equity deals fail, banks face exposure. This would be a true systemic crisis.

Fortunately, on a macro level, private credit funds are still relatively small and unlikely to pose systemic risks. However, the most worrying scenario is confidence collapsing first in the private credit market—especially in sectors heavily impacted by AI—then spreading to the public bond markets. This contagion path is plausible because, compared to the typically lean, high-growth companies financed by private credit, large corporations in the bond market are more vulnerable to automation and AI disruption.

What does this mean for RWA and DeFi?

The most immediate impact of the private credit crunch falls on capital allocators. Many private credit funds have been distributed to retail investors via publicly traded BDCs, private credit ETFs, or semi-liquid funds like Blackstone’s BCRED, Apollo’s Debt Solutions BDC, and BlackRock’s HPS Fund.

These funds share common features: quarterly (or monthly) redemption windows, often limited to 5% of NAV per quarter, targeting returns of 8-11%. Recently, some have started gating redemptions.

From a DeFi capital allocation perspective, the biggest risk is structural: how private credit is packaged in DeFi, often without full understanding by many retail users before they invest. We’ve seen countless examples: DeFi users actively deploying funds into high-yield real-world asset (RWA) strategies, only to later discover significant duration risk in the underlying exposures.

I believe RWAs represent one of DeFi’s greatest recent opportunities. But my biggest concern is that institutional speculators might treat DeFi as a channel to offload illiquid, distressed Wall Street products—essentially using DeFi participants as exit liquidity. Since assessing RWA opportunities is inherently more complex, this risk is amplified: RWAs lack the transparency or on-chain verifiability native to DeFi opportunities.

That said, if well integrated on-chain, private credit can offer what traditional finance cannot: enforceable guarantees via smart contracts. Redemption windows, withdrawal limits, collateral ratios, and distribution rules can be encoded immutably, preventing fund managers from arbitrarily changing terms after capital is committed. In traditional private credit, investors have paid dearly when market conditions worsen, only to see fund managers tighten or freeze redemptions at will. On-chain, these rules are transparent from day one and enforced by code—not subject to managerial discretion under pressure. This is the key advantage RWAs and DeFi can have over traditional models in this asset class.

To make RWAs succeed in DeFi and enable meaningful growth, the industry must thoughtfully and cautiously build bridges between TradFi and on-chain markets. This involves establishing strong transparency standards, proper risk disclosures, independent verification of collateral, and governance frameworks to protect on-chain participants from information asymmetries. Without these safeguards, the integration of TradFi and DeFi risks becoming pure extraction rather than value creation.

DeFi should not become Wall Street’s exit liquidity.