Aave V4 and Beyond: Bringing Capital Markets Onchain

Transcript

Oh wow. Hello everyone. Nice to see this amazing place. So, uh quick introduction. My name is Emilio. I've been working at Aave Labs since the beginning. Since Aave Labs was not even called Aave Labs, but it was actually called Ethlend. And I've been supervising the or being part of the core protocol development since the beginning.

Uh since Aave V1. I'm currently senior VP of engineering at Aave. And I am supervising and I have supervised and designed Aave protocol before. Uh which was released yesterday. And where is the applause? Come on. Uh yes. Let's go. Yes so uh what are we going to what are we going to talk today? Today we are going to talk what happens now. So, uh release day is always a big day.

Uh like there is a lot of effort going on. There is a lot of um electricity in the air when we release a new product a product iteration, but immediately after we start thinking about how we can continue evolving, how we can continue innovating. And today we are going to talk about how Aave Labs um through Aave V4 plans to bring uh um capital markets on chain, right? So, let's talk a bit about uh Aave V4 what change. Actually, uh raise your hand if you tried Aave V4 yet.

Okay. Okay, that's an astonishingly low number. So, >> [laughter] >> guys, we have to we have some catch up to do, yeah? Okay so what changes with V4 compared to Aave V3? So, the previous iterations of the protocol which were iterative over the first release of Aave V1 uh were all based on the same design on the same architecture which was which was monolithic. Uh so, every the Aave protocol was essentially identified as a market.

Every time you wanted to capture a different opportunity in terms of different asset classes, you could, for example, deploy new markets which brought a variety of complexities complexities around uh bootstrapping uh the liquidity and incentivizing bootstrapping the demand so that the flywheel of the yield could start, right? So, with Aave V4 we actually have a different approach where there are multiple components in within what we can uh compare to Aave V3 market.

Uh so, we have a liquidity the architecture is called hub and spoke design. So, we have one liquidity hub and multiple spokes that we can be connected to it. So, um what are the main reasons why we went for this kind of design? Uh we wanted what we noticed is uh while develop developing the different iterations of Aave, we noticed that um the liquidity provisioning part was pretty much common across all the iterations of the protocol that we had.

And the only things that were was evolving only thing that was evolving and changing over time was the borrowing approach, right? So, we were keeping adding feature on the borrowing side while the liquidity provisioning was staying more or less stable over the over the different iterations. So, the idea came to actually abstract away the liquidity provisioning part from the borrowing. So, this opens up a lot in terms of design space because now we can have pluggable borrowing strategies that can actually be integrated into one single hub, all of them sharing the same the the same liquidity. So, this allows us to actually uh move away from

one individual borrowing strategies which is deeply tied in how the protocol works and actually extend the protocol functional capabilities by adding different borrowing strategies that might be following very heterogeneous approaches. Okay? Uh we also added the first iteration of the protocol which is the one that we deployed yesterday uh covers pretty much the same use case as Aave V3 does in a more efficient way because like besides having added new features which we'll be reviewing quickly here, we also improved a variety of in terms of

efficiency, gas cost and so on. Uh so, the initial setup if you try if you're going to try V4, you will see that there are a variety of different configurations where now you can capture actually different multiple yield opportunities. Also comes with a variety of new features. I'm going to just list a few. There are many, but like the most important ones uh and I'm also going going to point out to the docs at the end of the of the presentation.

Uh we have I would say the most important ones are the risk premiums and the dynamic risk configuration. So, risk premiums are a way for the protocol to price collateral risk independently. This was not possible with Aave V3 because all the assets that were listed as collateral in Aave V3 were sharing the same borrowing costs. With V4, we introduced a new risk lever for risk to be able to price risk more appropriately or to manage assets whose risk parameters and risk profile change more drastically over time.

Another the other feature is dynamic risk configuration where we have now the possibility of changing the configuration for the collaterals in a way that doesn't affect all the borrowers like it was happening before with previous iterations, but we can basically change uh the risk configuration only for new users which opens up to the possibility of having having more granular risk control. And a better approach towards managing changing market conditions.

Uh we also have other features that are very very important. We added liquidations in a Dutch auction format which means that now uh if the risk managers believe it appropriate can the liquidations can be more optimized towards reducing exposure to the protocol or giving more possibilities to borrowers in terms of more optimized liquidations. We have an investment module feature which in my opinion especially to this day where the market is a bit in a depressed condition is very very important because this will allow um uh the DAO to actually move liquidity across

lower risk strategies to optimize yield in in in within Aave markets. Uh thinking [snorts] for example of stable coins that offer direct staking yield, right? So, when we have when we have a float on Aave like today there are there are multiple billions of floating liquidity on Aave that are currently unproductive. Thanks to their investment module, we can actually take this liquidity, stake in within for example the yield redistribution platform of the stable coin itself and make it so that like Aave depositors can get optimized yields.

And also position managers are a very cool feature that we added basically will allow the DAO to build a variety of tools on top to provide better user experience and better automation. Uh so, going back quickly to what we were talking about before, modularity also means scalability. Why? Because thanks to the fact that we have multiple borrowing strategies, we can also implement uh a variety of approaches that move potentially away from the ERC-20 as collateral model which is what defined pretty much all the lending protocols

until today, right? So, Aave V4 in reality moves away from like being a pure lending protocol and becomes a more of a liquidity provisioning protocol. So, a multiple borrowing strategy strategies plugging into the same liquidity layer to reduce liquidity fragmentation and to facilitate bootstrap of demand. Uh and with borrowing strategies that are possibly very much heterogeneous and very much different from what we have today. Uh this will allow us to unlock both on chain and off chain demand. That's what we are going to see shortly. [snorts] Uh so, this is one example of what we are going to build

over the course of the of this year and probably the next. Uh there are a couple of examples here, but we are planning to develop actually a lot of new borrowing strategies on top of Aave V4. This is one of the possibilities that Aave V4 unlocks. So, at the moment there is a lot of uh hidden demand in the forms of assets being deployed in custodians, right? So, what happens when a user uses usually use custodians for the added security guarantees because maybe they don't feel comfortable with self-custody, right? This also make it

so though that it becomes more complicated to access DeFi tools like Aave. Because the assets that could be are now used as collateral, they're actually into custodian infrastructure, right? So, one of the ways that we are thinking of unlocking this demand is not to force for example custodians to tokenize these positions, but rather to bring the technology to be able to do so directly into their infrastructure, right? So, let's imagine that we have a custodian that has a a on-chain wallet infrastructure to for for the custody of the funds. Then we can basically implement a new borrowing

strategy in the form of a spoke. This spoke will would allow the custodian to plug their custody infrastructure into the spoke which basically requires only two major constraints. Constraint that require enforced collateralization. So, the position remains collateralized at all times. And also possibility to liquidate these assets.

So, the possibility for the Aave protocol to access these assets whenever market condition require these assets to be sold to cover the debt, right? So, this would be in general what the flow this would represent the execution flow of a potential custodian spoke integration with the custodian infrastructure, implementation of the hooks to guarantee collateralization constraints and liquidation access. And the DAO reviews and approves the inclusion of this spoke in within the hub infrastructure or deploys a new hub.

Another cool feature that we have with Aave V4 is the possibility to share liquidity across hubs. So, potentially this could have its own hub with own liquidity provisioning, but also the possibility to share idle liquidity from other hubs like for example from the core hub. So, here we have a diagram of how this would work. We would have the Aave core hub. The custodian spoke could be integrated directly for example into the Aave core hub. Whenever we integrate spokes uh into hubs, every spoke will have a very precise uh debt ceiling. So, the DAO is basically able to set exact

exposure of how much liquidity we want to give access to this particular spoke. So, the custodian spoke would integrate with the smart wallet infrastructure with the custodians, withdraw liquidity from the Aave core hub up to the caps that were set by the DAO. And the custodian spoke would then enforce collateralization constraints and eventually liquidation if that comes to happen. Uh Another borrowing strategy that we are planning to implement, which is in very high demand today especially across institutionals is fixed fixed rate. So,

fixed rate borrowing with the ability of for borrowers to determine the borrow rates at which are borrowing to and maturity dates. So, until today basically the variable rates and perpetual duration of the loans have been dominating the space, right? So, Aave has this approach. Pretty much all the competitors have this approach. Uh Some protocols try in the past, we tried also with the previous before Aave we had Ethlend which was peer-to-peer based.

It didn't really pick up much traction back back then. And up until today no protocol basically managed to pick up meaningful traction following this approach. But we are now in a phase where new entities are joining the space in the form of institutionals institutional investors, fintech banks. There is a lot of interest in in DeFi across these entities. And most of these entities are actually used to certainty. So, these entities usually they want to borrow with predictable terms and predictable maturity dates.

And they don't want like their borrow rate starting at three and potentially ending at 20, which is something that sometimes happens in DeFi when there are dramatic surges in demand, right? So, this is definitely something that we are looking forward to build and is very high priority for us. Something that we believe will accelerate the adoption of DeFi across the institutional space. We have a variety of designs in mind. Like one potential design is like full peer-to-peer where you have uh lenders and borrowers setting up like kind of offers and requests where you have

essentially lenders require a set of collaterals and a certain yield and a certain durations. Borrower offer a certain collateral and a certain borrow rate and a certain duration and then you match them together. Or we can have more structured approach where the system automatically offers a set of tranches of in terms of possibilities. So, 30 60 90 120 days. And depending on the duration also it can give a certain borrow rate based on the average variable

rate of Aave for example. So, we are exploring both these possibilities. And this would be implemented in the form of a custom spoke that would essentially allow users suppliers especially to access the Aave liquidity whenever is whenever is the liquidity is not matched, right? Or not currently utilized in a borrowing position and then like the liquidity essentially gets matched automatically when a borrower comes with suitable terms.

This is for us is very important. This is direct priority and it is something that we already started working on. And we hope to release as soon as possible. Um So, the cool part of this that these strategies can be used not only with crypto collateral like, but they can be used with any collateral in any form that allows to be connected somehow with the blockchain. So, potentially we could have um situations in in which the collateral is actually either accessed to through a legal

infrastructure. The legal infrastructure posts data for example on the spoke and the and the spoke uses that data to validate the state of the loan and the collateral can for example be if needed liquidated off-chain and the debt repaid automatically on-chain. Or if the asset is suitable to be tokenized, it can be tokenized and tokenized representations can be used on-chain. With Aave V4 we can easily leverage both options. And and the cool part is that the DAO can actually become a off-chain custodian as well. The DAO could play a role in which it acts the DAO acts as intermediary of the spokes to be able to

make the off-chain agreements work. So, as I mentioned before, these are only a few of the ideas that we have coming going forward. Uh uh I think I believe that these spokes ultimately will allow Aave to access billions in idle demand that cannot be accessed today. And the role of the governance will be key because the role of the governance will be to actually validate the correct implementation of these spokes.

And through risk managers guarantee that the risk exposure of the protocol remains within the boundary of safety. Uh Yeah, this is pretty much it. I hope you guys enjoyed. I want to say Sunny yesterday finished with DeFi will win and I will I will finish with thanks to Aave V4 Aave will win. Thank you guys. I hope you enjoyed. And try Aave V4.