[AAVE] Collateral Onboarding Risk Evaluation

Legal Disclaimer: This communication is provided for information purposes only. This communication has been prepared based upon information, including market prices, data and other information, from sources believed to be reliable, but Maker has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any digital assets and the use of finance-related terminology are for illustrative purposes only, and do not constitute any recommendation for any action or an offer to provide investment advisory services. This content is not directed at nor intended for use by the MakerDAO community (“MakerDAO”), and may not under any circumstances be relied upon when making a decision to purchase any other digital asset referenced herein. The digital assets referenced herein currently face an uncertain regulatory landscape in not only the United States but also in many foreign jurisdictions, including but not limited to the UK, European Union, Singapore, Korea, Japan and China. The legal and regulatory risks inherent in referenced digital assets are not the subject of this content. For guidance regarding the possibility of said risks, one should consult with his or her own appropropriate legal and/or regulatory counsel. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any decision. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

  1. Summary Proposed Risk Parameters
  2. Overview
  3. Metrics and Analysis
  4. Risk Parameters

Summary Proposed Risk Parameters

Risk Premium: 6%
Liquidation Ratio: 175%
Debt Ceiling: 10 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 500 Dai


Protocol Summary

From Aave Documentation

Aave is a decentralized non-custodial money market protocol where users can participate as depositors or borrowers. Depositors provide liquidity to the market to earn a passive income, while borrowers are able to borrow in an overcollateralized (perpetually) or undercollateralized (one-block liquidity or flash loan) fashion.

The platform has 2 types of fees. From borrowers, a 0.00001% of the loan amount is collected on loan origination, from which 20% is used for referral integrators and 80% is allocated in the protocol fund. From Flash Loans, a 0.09% is collected from the loan amount, from which 70% is redirected as extra income for depositors of the protocol and 30% is split using the same 20%/80% model of the origination fee. There are also transaction fees for Ethereum Blockchain usage, these fees depend on the network status and transaction complexity.

No platform can be considered entirely risk free. The risks related to our platform are the smart contract risk (risk of a bug within the protocol code) and liquidation risk (risk on the collateral liquidation process). We take every possible step required to minimize the risk as much as possible-- the protocol code is public and open source and it has been audited. Additionally, we have an ongoing bug bounty campaign live and running.

AAVE is used as the center of gravity of Aave protocol governance AAVE is used to vote and decide on the outcome of Aave Improvement Proposals (AIPs). Apart from this AAVE can be staked within the protocol Safety Module to provide security/insurance to the protocol/depositors and that way earn staking rewards and fees from the protocol. We have released our documentation with specific details about tokenomics and governance for more details please check our flash paper our full documentation and join the discussion in our governance forum.

Aave is currently using Chainlink aggregator as a price oracle, but also has a proprietary fallback price oracle in case the prior fails.

Metrics and Analysis

Trading volume on CEX & non-custodial venues

AAVE is trading on several venues including FTX, Gemini while Binance is the dominant by trading volume. Amongst DEX venues, the most popular by far is Uniswap. As seen on the chart below, trading activity increased during the last month.

Source of data: CryptoCompare (CEX), Uniswap.info, Kyber Tracker, 0xTracker

Token distribution & Issuance schedule

The project was incepted during the 2017 ICO era, selling LEND tokens according to the distribution schedule; all team vested tokens and such were already fully vested, meaning all LEND tokens were free floating prior to token migration.

During last summer the project completed significant upgrades to the protocol and token. New protocol features demanded for a token with additional functionality (today’s AAVE) which was conducted via token migration. The migration is still undergoing, currently more than 91% of tokens have been migrated. The migration results in a 100:1 LEND:AAVE rate, reducing the supply by a factor of 100. The project also created additional supply of 3M tokens or 23% (13M->16M), where new supply is allocated to the Aave Ecosystem Reserve. The reserve was established as a safety and ecosystem incentive, but is currently only used for safety incentives. They reward users who stake their AAVE as a collateral of last resort. The safety incentive is currently set to 400 AAVE distributed between stakers daily, which currently results in ~5% APY based on the current amount of staked tokens (2.9M tokens) Additionally, fees collected by the protocol are allocated to an account owned by the governance and are currently not being distributed yet. Based on Aavewatch, the protocol accrued about ~$500k in fees to date, evenly distributed between flash loans and normal borrowing fees.

Token Deposits on Trading Venues

Majority of tokens deposited on centralized venues are on Binance which is consistent with the reported trading activity. Aave does not have a clear dominant non-custodial trading venue.

Source of data: Nansen

Downside Risk

For this analysis we constructed the price feed for AAVE with addition of historical LEND prices normalized by token supply. The observed period is one year and as it is evident that AAVE tends to have higher frequency and severity of negative pullbacks. Largest pullback was recorded during the event of Black Thursday in March, when LEND dropped for -47.76% in one day.

Source of data: CoinMarketCap

Total Value Locked (USD)

Assets supplied in the protocol increased rapidly during summer of 2020, when liquidity mining was the most popular and profitable. The abnormally high liquidity mining yields in the ecosystem caused several token interest rates on lending platforms to spike, which pulled a lot of deposits and activity to the protocol. For comparison, Compound protocol which is the strongest competitor in the space, currently only leads the TVL metrics by 22%.

Source: DefiPulse

Total Borrow Volume

As opposed to the TVL metric, Compound is leading for much more in the Total Borrow Volume as seen on the chart below. Assets on Compound are utilized much more compared to Aave. The main reason for this dynamic lies in the difference between listed assets on the platform and economic activity of the users. Large share of TVL on Aave is due to assets such as YFI, AAVE, LINK and REN which are not present on Compound. Additionally many positions in Compound are purely constructed for liquidity mining, highly leveraged and would otherwise be non-economic sensible positions. These reasons increase the asset utilization and volume on Compound, while Aave holds a larger amount of actual economically sensible positions such as short and leveraged long positions.

Source: DeBank

AAVE governance has an ability to enable Ecosystem Incentives, which are a similar concept as COMP liquidity mining, but the feature is currently not utilized.

DeFi Presence

  • 3.3M tokens supplied to Aave protocol as collateral, the asset is not enabled for borrowing and lending.
  • 2.9M tokens supplied to Aave Safety Module
  • 115K tokens as liquidity in Uniswap

Summary of Notable Risks

  • Majority of trading activity is conducted on Binance.
  • DEX volume is relatively low, especially for an asset with such high market capitalization and popularity in the space.
  • AAVE token is enabled as collateral in the protocol, but AAVE tokens deposited in Safety Module serve as insurance/security to the protocol/deposits. This combination can produce unexpected instances where large selling pressure is put on the token.
  • General risks with secondary lenders where aggressive policy of adding new collateral is performed. There are also risks known to secondary lending venues such as bank runs and inability to redeem supplied funds.

Proposed Risk Parameters

Risk Premium: 6%
Liquidation Ratio: 175%
Debt Ceiling: 10 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 500 Dai

We used the model from the Collateral Risk Assessment Guide here. Inputs to the model are derived from trading data along with stressed input parameters. A link to our model specification with inputs and outputs can be found here. Auction parameters have been selected to mirror those for ETH.

Lead researcher: Marko Štemberger



Thank you very much @rema – the Community really appreciates the work you put into this evaluation.

It’s truly astonishing how in less than 12 months AAVE has increased it’s TVL and already contributed over $1B in flash loans. Super awesome.

Also, RWA are coming soon to AAVE:

" Below is an overview of how one of such securitisation players - CrescoFin - intends to organise the process and then have these assets sit on Aave, a money-market protocol similar to Compound"

“It’s a complex mechanism, but simply put, the securitised pool of assets can be ‘deposited’ onto an Aave account, where it can potentially generate additional yield or be used as collateral for new loans. Aave tokenholders therefore benefit from the growth of their ecosystem with CrescoFin assets flowing in, while the asset provider benefits from immediately leveraging the crypto pool of capital and composability features it offers.”

Quotes and Chart courtesy of The Financier 2.0


Amazing work @rema. I learnt a lot. Very instructive post

Thanks @rema. A bit surprisingly, Aave on-chain liquidity isn’t as good compared to other DeFi high market cap tokens. This is why 10m DC already carries 6% RP. If we were to see high debt utilization and potentially decide to increase DC, we might need to start charging double digit fees.

1 Like