Interpreting Aave V4: A Transition from Product to "Bank"

Original title:《Interpreting Aave V4: A Shift from Product to “Banking”》

Original author: Eric, Foresight News

Late in the evening of March 30, Beijing time, the Aave V4 version—first approved and put in motion in 2024—was officially launched on the mainnet, bringing the first piece of good news since the Aave DAO governance controversy.

The V4 version can be described as an overhaul and complete rebuild of Aave. The most core change is the integration of the previously separate lending markets into a unified liquidity pool architecture: Hub and Spoke (hub and spoke).

In the V4 version, each chain or L2 has a unified liquidity center (i.e., the Hub). All assets deposited by users for lending will be stored in a single liquidity pool. The Hub is responsible for global coordination, credit limit control, system-level constraints (such as “total borrowing ≤ total supply”), and emergency pauses. The Hub does not directly face users; instead, it manages liquidity behind the scenes in a unified way.

It is worth noting that it is not the case that each chain has only one Hub. Instead, different Hubs are designed based on different needs, which is also, in essence, a form of risk isolation. For example, V4 has currently launched the Core Hub, Prime Hub, and Plus Hub. Core Hub includes mainstream assets and is for all users. Prime Hub is designed for suppliers seeking more “controllable” collateral. Plus Hub is designed for strategy-style stablecoins, and its parameter design needs to take into account the scale of the project.

As for Spoke, you can understand it as an independent market. Each market has independent lending and borrowing functionality, risk parameters, and collateral rules. Within a Hub, users’ assets exist in the same liquidity pool, and borrowers need to select different Spokes based on their needs. For example, as shown in the figure above, users can deposit WETH as the borrowable asset, and borrowers in the first four Spokes can all borrow WETH, but only the EtherFi Spoke can use weETH as collateral.

Although the official claim is that fragmented liquidity can be integrated, in practice, there is actually not much difference for users borrowing by posting high-quality collateral. For instance, if you want to collateralize ETH to borrow assets, the operation in V3 and V4 is not different—so long as you can keep the health factor from being too low.

So in terms of liquidity integration, V4 is indeed more granular to manage than independent markets, but it does not amount to a qualitative leap. The real difference comes from Spoke-customized parameters and a new liquidation engine.

In V4, a borrower’s interest rate depends on the base rate and the risk premium. The base rate still uses a utilization curve as in V3—rising gradually below the optimal utilization rate, and then rising steeply afterward. The risk premium depends on the nature of the collateral asset. If the collateral is more stable assets like USDT, ETH, WBTC, etc., then the risk premium is very small or even 0. But for high-risk meme coins and other high-risk altcoins, the risk premium can be very high, avoiding the situation of “good assets subsidizing bad assets.”

Take a simple example. In V3, interest rates depend entirely on supply and demand. Borrowing out USDT in the same way may have differences in the borrowing limit (LTV) and liquidation thresholds, but the interest rate on collateralized ETH and LINK under the same supply-demand conditions is the same. However, clearly, LINK’s volatility is higher than ETH’s. If interest rates are the same, borrowers collateralizing LINK will drive up utilization, which can cause the problem that users collateralizing ETH see their borrowing costs rise rather than fall.

V4 fixes this shortcoming: users borrowing by collateralizing high-risk assets must pay higher costs, while users providing liquidity can also earn higher returns. Meanwhile, higher interest rates also limit borrowing demand, making the cost advantage for users borrowing with high-quality collateral even more obvious.

In terms of the liquidation mechanism, liquidators will only restore the health factor to the Spoke’s preset target value, and the lower the health factor, the higher the liquidation bonus. This design not only gives borrowers more room to operate, but also reduces the platform-wide risk of bad debt. In addition, the new liquidation engine also adds a “dust protection mechanism”—when remaining debt or collateral falls below a threshold (such as $1,000), liquidators must fully close out their position to prevent small residual amounts from accumulating and reducing capital efficiency.

Finally, idle liquidity in the Hub can be automatically invested into low-risk yield strategies approved by governance (such as short-term treasuries, stablecoin LPs, money market instruments, and so on). While increasing income for liquidity providers, it also increases DAO income—this might be one of the few advantages under “unified liquidity.”

Overall, the advantages brought by Aave V4’s unified liquidity in lending and borrowing are not particularly significant. The so-called composability—meaning that borrowing users can manage positions across different Spokes in a unified way—does not make it much more convenient than V3. But as the author said in the title, V4 turns Aave from a product into a financial infrastructure similar to a “bank.”

Leaving aside all kinds of complex businesses, the most core business of a bank is taking deposits, keeping a portion as reserves for users’ everyday needs like payments and transfers, and then earning the net interest spread by lending out the remaining funds. As for idle funds, a bank can also allocate them to different investments within the bounds of its risk tolerance.

St. George Bank Headquarters, St. George’s Palace

Established in 1407 in Genoa, Italy, St. George Bank is generally considered the earliest bank in the world. In addition to offering deposit and loan services, the bank also handled government debt management, currency exchange, and fund transfers—meeting the commercial needs of Genoa at the time as a major European trade center.

From the launch of ETHLend in 2017 to the launch of Aave V4 in 2026, in less than 10 years, Aave has been made into the shape of the original bank. Of course, there are significant differences between Aave and banks; this is just an analogy. Compared with P2P, the bank model—one that has been pounded by countless black swans over hundreds of years—is naturally a better choice, just as V4 is to V3.

If you look closely, you will find that in the DeFi space, a large number of “innovations” have almost turned into historical dust. For example, the hot DeFi 2.0 in the second half of 2021. Instead, it is Aave—whose business is simple and whose underlying logic has been “seasoned” in traditional finance for hundreds of years—that has survived, and the more it lives, the better it gets. After years of exploration, many DeFi projects likely have discovered this problem: DeFi’s ceiling is very high, but the path that traditional finance has walked cannot be missed.

Aave V4 concentrates liquidity, and there is a lot that can be done in the future. For example, it could invest assets whose idle time exceeds a certain threshold (for example, one year) into investments with relatively higher risk—such as setting up ETH/USDT LP on Uniswap. It could operate entirely in the mode of a commercial bank, and gradually expand into other businesses of a commercial bank, such as credit cards (for reference, Ethfi’s model of using collateralized borrowing to pay for stablecoin consumption), and so on.

Going one step further, Aave can also expand into “investment banking.” For example, by launching an ICO platform, users who deposit assets to earn interest could borrow USDT and USDC to participate in investments, without needing to withdraw the assets and sell them to obtain the stablecoins required to participate in the ICO. In this way, it can charge fees to projects on one side, while earning interest on the other.

Although the Hub & Spoke mechanism itself does not bring much in the way of innovation in the lending and borrowing process, it has made the most important groundwork for the next step. **