Original title: "Detailed Explanation of AAVE V4 Upgrade: Reshaping Lending with Modularity, Can the Old Currency Usher in a New Spring?"

Original author: Umbrella, Deep Tide TechFlow

On the evening of the 25th, AAVE founder Stani’s post announcing the upcoming launch of AAVE V 4 quickly attracted a lot of attention and discussion. The recent dispute between AAVE and WLFI over the 7% token distribution proposal has also been a hot topic in the market.

For a time, the market's attention was focused on AAVE, a long-established lending protocol.

Although the dispute between AAVE and WLFI has not yet reached a final conclusion, behind this "farce" seems to be a different picture - "new coins are constantly changing, but AAVE is forever."

With the emergence of more and more new coins, stimulated by the demand for fixed token lending on the chain, AAVE undoubtedly has good fundamentals and catalysts.

This V 4 update may allow us to see its strong future competitiveness in the DeFi field and the root cause of its growing business volume.

From lending protocols to DeFi infrastructure

When we discuss AAVE V 4, we first need to understand a key question: why is the market looking forward to this upgrade?

From ETHLend in 2017 to today's DeFi giant with a TVL of US$38.6 billion, as an old protocol, every version update of AAVE in the past has actually been optimized and can affect the liquidity and gameplay of on-chain assets to varying degrees.

The version history of AAVE is actually the evolution history of DeFi lending.

When V1 launched in early 2020, the total locked-in value in DeFi was less than $1 billion. AAVE adopted a liquidity pool, replacing the peer-to-peer model, transforming lending from a "wait for matching" process to an "instant transaction." This change helped AAVE quickly gain market share.

V2 launched at the end of 2020, with key innovations in flash loans and debt tokenization. Flash loans spawned an arbitrage and liquidation ecosystem, becoming a key revenue source for the protocol. Debt tokenization enabled position transferability, paving the way for subsequent yield aggregators. V3, released in 2022, focused on cross-chain interoperability, allowing more on-chain assets to enter AAVE, becoming a multi-chain liquidity connector.

More importantly, AAVE has become a pricing benchmark. DeFi protocols reference AAVE’s supply and demand curve when designing interest rates. New projects also benchmark AAVE parameters when choosing collateralization rates.

However, despite being an infrastructure, the architectural limitations of V 3 are becoming increasingly apparent.

The biggest problem is fragmented liquidity. AAVE currently has $60 billion in TVL on Ethereum, Arbitrum has only $4.4 billion, and Base is even less. Each chain is an independent kingdom, hindering the efficient flow of funds. This not only reduces capital efficiency but also restricts the development of smaller chains.

The second issue is the bottleneck of innovation. Any new feature must go through a complete governance process, which often takes months from proposal to implementation. In the rapidly iterating environment of DeFi, this pace clearly cannot keep up with market demand.

The third issue is the inability to meet customized requirements. RWA projects require KYC, GameFi requires NFT staking, and institutions require segregated pools. However, V3's unified architecture struggles to meet these diverse needs. It's either all or nothing; there's no middle ground.

This is the core problem that V 4 aims to solve: how to transform AAVE from a powerful but rigid product into a flexible and open platform.

V 4 Upgrade

According to publicly available information, the core improvement direction of V4 is to introduce a "Unified Liquidity Layer" and adopt a Hub-Spoke model to change the existing technical design and even the business model.

Image source: @Eli 5 DeFi

Hub-Spoke: Solving the Problem of Wanting More Than Just One

Simply put, the Hub aggregates all liquidity, while Spokes handle specific operations. Users always interact through Spokes, and each Spoke can have its own rules and risk parameters.

What does this mean? It means that AAVE no longer needs to serve everyone with one set of rules, but can allow different Spokes to serve different needs.

For example, Frax Finance could create a dedicated Spoke that only accepts frxETH and FRAX as collateral and sets more aggressive parameters; at the same time, an "Institutional Spoke" might only accept BTC and ETH, require KYC, but offer lower interest rates.

Two Spokes share the liquidity of the same Hub, but are isolated from each other's risks.

The ingenuity of this architecture lies in its ability to solve the "want both" dilemma: deep liquidity and risk isolation; unified management and flexible customization. Previously, these were contradictory within AAVE, but the Hub-Spoke model allows them to coexist.

Dynamic risk premium mechanism

In addition to the Hub-Spoke architecture, V 4 also introduced a dynamic risk premium mechanism, which revolutionized the way lending rates are set.

Unlike V3's uniform interest rate model, V4 dynamically adjusts interest rates based on collateral quality and market liquidity. For example, highly liquid assets like WETH enjoy a base interest rate, while more volatile assets like LINK pay a premium. This mechanism, automated through smart contracts, not only enhances protocol security but also makes borrowing costs more equitable.

Smart Account

V4's Smart Account feature makes user operations more efficient. Previously, users had to switch wallets between different chains or markets, making managing complex positions time-consuming and laborious. Now, Smart Accounts allow users to manage multi-chain assets and lending strategies through a single wallet, reducing the number of steps required.

A user can adjust WETH collateral on Ethereum and borrow money on Aptos within the same interface, eliminating the need for manual cross-chain transfers. This streamlined experience makes it easier for both retail users and professional traders to participate in DeFi.

Cross-chain and RWA: Expanding the boundaries of DeFi

V4 leverages Chainlink CCIP to enable cross-chain interactions within seconds, supporting non-EVM chains like Aptos and allowing more assets to seamlessly connect to AAVE. For example, a user can collateralize assets on Polygon and borrow or lend on Arbitrum, all in a single transaction. Furthermore, V4 integrates real-world assets (RWAs), such as tokenized treasuries, opening new avenues for institutional capital to enter DeFi. This not only expands AAVE's asset base but also makes the lending market more inclusive.

Market reaction

Although AAVE experienced a sharp drop this week along with the broader crypto market, its rebound today was significantly stronger than other leading DeFi targets.

After the crypto market experienced a plunge this week, AAVE tokens saw a total network trading volume of $18.72 million within 24 hours, far higher than Uni's $7.2 million and Ldo's $3.65 million, reflecting investors' positive response to protocol innovation, and the increase in trading activity has further enhanced liquidity.

TVL more directly reflects the market's recognition. Compared to early August, AAVE's TVL has surged 19% this month, reaching a record high of nearly $70 billion and currently ranking first in TVL on the Ethereum blockchain. This growth far exceeds the DeFi market average. The increase in TVL also validates the effectiveness of AAVE V4's multi-asset support strategy, perhaps signaling the influx of institutional capital.

According to TokenLogic data, AAVE's total net assets have reached a new high of US$132.7 million (excluding AAVE token holdings), an increase of approximately 130% in the past year.

In terms of on-chain data, as of August 24, the open interest on AAVE exceeded US$430 million, setting a six-month high.

In addition to the intuitive data, AAVE's upgrade has also aroused widespread discussion in the community. The preliminary information released by V 4 has also received a lot of support and recognition, especially in terms of capital utilization and composable DeFi, allowing the market to see more possibilities and potential.

Make DeFi great again

Based on the updates that have been disclosed so far, this AAVE upgrade is likely to lead the DeFi market to a higher level. The upgrade highlights such as modular architecture, cross-chain expansion and RWA integration have not only ignited market enthusiasm, but also driven up prices and TVL.

And its founder Stani also seems to be confident about the impact of the V 4 upgrade on the DeFi track.

Perhaps in the near future, AAVE will take advantage of the liquidity "east wind" brought by the crypto bull market to soar and open up unlimited possibilities.

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