Aave is ceding the DeFi lending throne due to its own folly

Original | Odaily (Planet Daily) (@OdailyChina)

Author | Azuma (@azuma_eth)

$292 million - that's the total amount of rsETH stolen from Kelp DAO; $17.2 billion - that's the total value of funds that have flowed out of Aave since the incident.

Aave, due to its incredibly poor crisis management strategy, has allowed community panic to fester for days, consequently losing its two greatest advantages in the lending arena: hundreds of billions of dollars in locked capital and the user perception of being the "safest DeFi" protocol.

• Odaily Note: For background, please refer to "DeFi suffers another $292 million theft; even Aave is no longer safe?"; "The three-way game under the $290 million hole: Who pays - Aave, L0, or Kelp?".

What Did Aave Do Wrong?

There's no need to dwell on the details of the Kelp DAO hack. Blaming Aave for granting such a high LTV to rsETH is pointless now. The focus here, from the perspective of a long-term AAVE user, is on Aave's response strategy after the incident.

First, the scale of the bad debt. Aave itself has done the math. Depending on how the rsETH is handled, there are two possible bad debt scenarios: If the stolen loss is deducted from all circulating rsETH, an estimated $123.7 million in bad debt would be created. If the value of mainnet rsETH is guaranteed and the loss is entirely allocated to the mapped rsETH on Layer 2, an estimated $230.1 million in bad debt would be created.

In either case, Aave has the financial strength to cover it with its Umbrella, DAO treasury, and team reserves. I understand that Aave doesn't want to foot the entire bill itself and hopes that the primary responsible party, Kelp DAO, and the secondary party, LayerZero, will also contribute significantly. But the problem is that they are thinking the same: "Aave is so wealthy and the situation is so awkward for you; shouldn't you bear more responsibility?" So, short-term negotiations among the three are unlikely to reach a consensus, meaning a win-win solution is temporarily out of reach.

But users simply can't afford to wait that long. Aave has never been particularly competitive in terms of yields. Users deposit their funds on Aave for its reputation, security, and liquidity. Now, however, in the most tense days following the incident, Aave failed to give users a certain promise like a backstop. Instead, it kept deflecting blame by emphasizing, "our code is not the problem" and "Aave has no control over how rsETH is accounted for."

So, the panic continued to ferment within the community. Users scrambled to escape. Those who could withdraw directly did so, and those who couldn't borrowed from other pools first, leading to a cascading effect. Now, Aave is facing a continuous outflow of funds on one hand, and liquidity crunches in several pools due to maxed-out utilization rates on the other.

This awkward situation could have been avoided (or at least been much less severe). ... If Aave could afford to pay, why didn't it just inject some confidence into the community from the start to prevent a bank run? It's a maximum bad debt of $230 million (probably less). It's unlikely that Aave would have had to bear the entire cost alone anyway; it could have haggled with LayerZero and Kelp DAO later.

Now, look at the outcome. To avoid promising up to $230 million in relief, Aave has watched $17.2 billion in locked capital drain away (and the number is still growing), not to mention the recent decline in the AAVE token price... No matter how you calculate it, it's a terrible deal.

What's worse for Aave is that the more dire its situation becomes, the more comfortable its counterparts like LayerZero and Kelp DAO become. They will judge that Aave has a greater incentive to solve the problem quickly, which only puts Aave at a negotiating disadvantage.

Aave has only itself to blame for getting to this point.

Lurking Behind Aave, Spark is Poised to Strike

While Aave is nursing a headache, competitor Spark is thriving. What's even more ironic is that Spark is a competitor "personally incubated" by Aave.

Spark is a lending protocol originally forked by Sky (formerly MakerDAO) from Aave V3's open-source code, meaning they essentially use the same underlying code logic. As a return, Spark had a profit-sharing agreement with Aave, but Aave later accused Spark of breach of contract. Combined with diverging roadmaps, the two are now purely competitors.

Three months before the Kelp DAO hack, Spark had just removed support for rsETH (details in "Same day, different fate: Aave embraces rsETH, loses nearly $200 million; Spark exits unscathed"). You can call it strategic conservatism, strict risk management, or sheer luck, but the result is that Spark was completely unaffected by this incident. On this point alone, Spark can freely attack Aave's former "safest DeFi" label.

Consequently, Spark became one of the safe havens for funds fleeing Aave. Since the incident, Spark's TVL has grown by nearly $2 billion (green part in the image below). On the day of the incident, Justin Sun withdrew 53,665 ETH (worth $124 million) from Aave and deposited it into Spark. After accumulating more in recent days, his total deposit stands at $1.3 billion. In the DeFi world, you really have to learn from Justin's moves.

On April 23rd, Upbit officially listed Spark (SPK) in the Korean Won trading market. Stimulated by this positive news, SPK's price surged over 80% in a single day, significantly narrowing its market cap gap with AAVE.

Even fish pond founder Wang Chun commented on X: "In the past year, I received 83.7 million SPK rewards from Spark and sold them on CoWSwap, swapping them for 663 ETH and $1.4 million. I'm a bit regretful now."

Spark clearly recognized this as a golden opportunity to snatch market share from Aave. Since the incident, Spark's Strategy Lead, MonetSupply, has become the loudest KOL on the matter, posting dozens of times a day. While his statements do help the public understand what's happening, they have objectively intensified the panic surrounding Aave.

But that's just pure business competition. MonetSupply simply made the right call.

Aave is Losing the DeFi Lending Throne

Early on April 24th, perhaps realizing the severity of the situation, Aave founder Stani announced on X the launch of a relief plan called "DeFi United," with participating partners including LayerZero, Ethena, ether.fi, the Ink Foundation, the Golem Foundation, Trydo, and others. Stani will personally donate 5,000 ETH to help address the current issues.

But the capital has already flowed out, and user trust has been severely damaged. With this belated statement alone, Aave will find it difficult to reclaim the locked capital and user trust in the short term.

The DeFi lending track has long seen a "one dominant player, multiple strong challengers" landscape. Aave had a seemingly extremely stable lead. Now, however, Aave has voluntarily given up its throne. Behind it, challengers are formidable. Besides the surging Spark, other competitors like Morpho and Jupiter Lend are also looking to take a slice from Aave.

Last year, Stani bought a five-story mansion in London for about $30 million, one of the most expensive transactions in the UK's sluggish luxury real estate market. I don't know if it's some kind of "jinx," but following precedents like Su Zhu, it seems that big spenders in the crypto world often run into bad luck.

I can't guess what Stani is thinking in his five-story mansion right now.