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 capital outflow from Aave since the incident.

Aave, through its incredibly poor crisis management, is allowing community panic to fester for days, thereby losing its biggest advantage in the lending track: hundreds of billions of dollars in deposited capital and the user-perceived label of being the "safest DeFi" protocol.

• Odaily Note: For background, please refer to: DeFi Hacked Again for $292 Million. Is Aave No Longer Safe?; The $290 Million Hole: A Three-Way Game Between Aave, LayerZero, and Kelp – Who Pays?.

What Did Aave Do Wrong?

The details of the Kelp DAO hack need little repeating. Blaming Aave for granting rsETH such a high LTV is also pointless now. The focus here, from a long-term AAVE user's perspective, is to discuss Aave's response strategy after the incident.

First, the scale of bad debt. Aave itself did the calculations. Depending on how rsETH is handled, there are two potential bad debt scenarios – if the stolen losses are deducted from all circulating rsETH, it's estimated to create a $123.7 million shortfall; if the value of mainnet rsETH is protected, attributing all losses to the bridged rsETH on Layer 2, the estimated bad debt would be $230.1 million.

In either scenario, Aave has the financial strength to cover it, thanks to its Umbrella fund, DAO treasury, and team reserves. I understand Aave doesn't want to foot the entire bill and hopes the primary responsible party, Kelp DAO, and the secondary party, LayerZero, would also contribute significantly. But the problem is they think the same way – "Aave is so wealthy and in such an awkward position; they should bear more responsibility." So, in the short term, negotiations between these three are unlikely to reach a consensus, meaning a satisfactory solution for everyone is temporarily out of reach.

However, users cannot wait that long. Aave's yield rates have never been particularly competitive. Users deposit into Aave for its reputation, security, and liquidity. Yet, during the most critical days following the incident, Aave failed to offer users any kind of backstop commitment. Instead, it repeatedly deflected blame by stating "our code is fine" and "we can't control how rsETH is accounted for."

Consequently, panic continued to ferment within the community. Users scrambled to exit and protect themselves – those who could withdraw did so directly; those who couldn't borrowed from other pools, escalating the impact. So now, Aave faces a continuous capital outflow on one hand and liquidity crises in multiple pools due to maxed-out utilization rates on the other.

This awkward situation could have been avoided (or at least been less severe). Since Aave can afford it, why didn't it reassure the community from the start to prevent a bank run? It's a maximum bad debt of $230 million (potentially less), which Aave wouldn't have to shoulder alone anyway. They could have bickered with LayerZero and Kelp DAO afterwards.

Now look at the result: To avoid committing to a maximum of $230 million in relief, Aave watched $17.2 billion in deposited capital flee (a number that may grow), not to mention the concurrent drop in the AAVE token price. No matter how you calculate it, this is a terrible deal.

To make matters worse for Aave, the worse its situation gets, the more relaxed counterparties like LayerZero and Kelp DAO become. They'll likely judge that Aave has more incentive to resolve the issue quickly, putting Aave at a disadvantage in the negotiations.

Having reached this point, Aave has no one to blame but itself.

Looming Behind Aave: A Hungry Spark

While Aave grapples with its headache, competitor Spark is thriving, basking in glory. Ironically, Spark is a competitor that Aave essentially "incubated" itself.

Spark is a lending protocol forked from Aave V3's open-source code by Sky (formerly MakerDAO). Both share the same underlying code logic. In return, Spark and Aave once had a profit-sharing agreement. However, Aave later accused Spark of breaching the agreement, and diverging roadmaps have led the two to become pure competitors.

Three months before the Kelp DAO hack, Spark had just removed support for rsETH (details: Different Fates on the Same Day: Aave Embraces rsETH, Loses Nearly $200M; Spark Exits Unscathed). Call it strategic conservatism, rigorous risk control, or just plain luck – the result is Spark emerged completely unscathed from this incident. On this point alone, Spark can relentlessly attack Aave's former "safest DeFi" label.

Consequently, Spark became one of the safe havens for capital fleeing Aave. Since the incident, Spark's TVL has grown by nearly $2 billion (green portion in the chart below). On the day of the hack, Justin Sun withdrew 53,665 ETH ($124 million) from Aave and deposited it into Spark. After accumulating further over the following days, his total deposit in Spark has reached $1.3 billion. In the DeFi world, you should learn from Justin Sun's moves.

On April 23, Upbit officially listed Spark (SPK) in its Korean Won trading market. SPK surged over 80% in a single day on the news, significantly narrowing the market cap gap between itself and AAVE.

Even Fish Pool founder Wang Chun lamented on X: "In the past year, I received 83.7 million SPK rewards from Spark and sold them on CoWSwap for 663 ETH and $1.4 million. I kind of regret it now."

Spark clearly recognized this as a golden opportunity to grab market share from Aave. Since the incident, Spark's Strategy Lead, MonetSupply, has arguably become the most prolific KOL on the matter, posting dozens of times a day. While his posts do help the public understand the situation, they have objectively exacerbated the panic surrounding Aave.

But this is pure business competition. MonetSupply is simply making the most optimal moves.

Aave is Losing its Throne in DeFi Lending

In the early hours of April 24, seemingly aware of the dire situation, Aave founder Stani announced on X a relief initiative called "DeFi United," with partners including LayerZero, Ethena, ether.fi, Ink Foundation, Golem Foundation, and Trydo. Stani personally donated 5,000 ETH to address the issue.

But the capital is gone. User trust is severely damaged. With only this belated statement, it will be difficult for Aave to quickly reclaim its lost TVL and user confidence.

The DeFi lending track has long seen a "one superpower, multiple strong players" structure, with Aave seemingly holding an unshakeable lead. Now, Aave has voluntarily given up the throne. Looming behind, challengers are formidable. Besides the surging Spark, others like Morpho and Jupiter Lend are also eager to take a bite out of Aave's market share.

Last year, Stani purchased a five-story luxury mansion in London for approximately $30 million, one of the most expensive deals in the UK's sluggish luxury real estate market that year. I don't know if there's some kind of "jinx," but precedents like Su Zhu suggest that big spenders in the crypto circle often end up running into bad luck.

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