Is Aave's value underestimated? Unveiling the reasons for its role as a core pillar of Decentralized Finance and on-chain economy.

On-chain lending, as one of the most critical markets in the crypto industry, Aave is undoubtedly a leader in this field, possessing strong competitive advantages and user stickiness. We believe that Aave's true value has not yet been fully recognized by the market, and its growth potential is enormous.

Since its launch on the Ethereum mainnet in January 2020, Aave has been around for nearly 5 years. Today, it has become the largest lending protocol, with a total active loan amount reaching $7.5 billion, which is 5 times that of the second-ranked lending platform.

The protocol metrics continue to grow, surpassing the previous bull market peak.

Aave is one of the few DeFi protocols whose metrics have surpassed the levels of the 2021 bull market. Notably, its quarterly revenue has exceeded the peak of the bull market in Q4 2021. More impressively, even during the market downturn from November 2022 to October 2023, Aave's revenue has continued to show accelerated growth. With the market warming up in the first and second quarters of 2024, Aave's momentum remains strong, with a month-on-month growth rate reaching 50-60%.

Since the beginning of the year, thanks to the increase in deposits and the price rise of underlying assets such as WBTC and ETH, Aave's total locked value (TVL) has nearly doubled, recovering to 51% of the peak in the 2021 cycle. This indicates that Aave has demonstrated stronger resilience compared to other leading Decentralized Finance protocols.

Strong profit performance reflects a high alignment between the product and the market.

Aave's revenue peaked in the last cycle, coinciding with multiple smart contract platforms issuing a large amount of token incentives to attract users and liquidity. This brought about unsustainable speculative capital and leverage levels, amplifying the revenue figures of most protocols.

Today, the token incentives of the main chain have been exhausted, and Aave's own token incentives have also dropped to negligible levels. This indicates that the growth in metrics over the past few months has been organic and sustainable, driven primarily by a recovery in market speculation activities, which has pushed up active lending and borrowing rates.

Moreover, even during periods of reduced speculative activity, Aave has demonstrated the ability to drive fundamental growth. In early August, when the global risk asset market experienced a significant downturn, Aave's revenue remained robust, thanks to its successful collection of liquidation fees during the loan repayment process. This proves that Aave has the capability to withstand market fluctuations across different collateral and multi-chain environments.

Strong fundamental recovery, Aave's price-to-sales ratio remains at its lowest level in three years.

Despite a strong recovery in indicators over the past few months, Aave's price-to-sales ratio is only 17 times, the lowest level in three years, significantly below the median level of 62 times during the same period.

Aave is expected to strengthen its dominance in the Decentralized Finance lending space.

Aave's competitive advantages are mainly reflected in four points:

1. The protocol has a good record of security management: So far, Aave has not experienced any significant smart contract-level security incidents. A strong risk management capability resulting in a good safety record is often the primary consideration for DeFi users when choosing a lending platform, especially for whale users holding large amounts of funds.

2. Bilateral Network Effect: DeFi lending is a typical two-sided market. Depositors and borrowers make up the supply and demand sides. Growth on one side drives growth on the other, making it increasingly difficult for newcomers to catch up. Moreover, the overall liquidity of the platform being more abundant allows for smoother liquidity movements for depositors and borrowers, enhancing the platform's appeal to large capital users, which in turn can stimulate further growth of the platform's business.

3. Effective DAO Management: The Aave protocol has fully implemented a DAO-based management model. Compared to centralized team management models, DAOs involve more comprehensive information disclosure and more thorough community discussions. In addition, Aave's DAO community brings together a group of highly skilled governance professional organizations, such as top risk management service providers, market makers, third-party development teams, and financial advisory teams. This diverse participant structure contributes to active governance participation on the platform.

4. Multi-chain ecosystem positioning: Aave has been deployed on almost all mainstream EVM L1/L2, and its TVL remains leading on all deployed chains except BNB Chain. The upcoming Aave V4 version will facilitate cross-chain liquidity, further highlighting its cross-chain liquidity advantages.

Reform the token economics, promote value accumulation, and eliminate reduction risks.

The Aave Chan Initiative (ACI) has just launched a proposal aimed at reforming the AAVE token economics, hoping to introduce a revenue sharing mechanism to enhance the token's utility.

The first major change is the elimination of the risk of AAVE being reduced when moving the security module. Based on the brand new Umbrella security module, stkAAVE and stkABPT will be replaced by stk aToken, with the first ones being aUSDC and awETH. aUSDC and awETH suppliers can choose to stake assets to earn additional fees (including AAVE, GHO, and protocol income) beyond the interest paid by borrowers. These staked assets face the risk of reduction and destruction during shortage events.

In addition, the yield distribution mechanism will further enhance the demand for AAVE. The introduction of the Anti-GHO token will strengthen the alignment of interests between AAVE stakers and GHO borrowers, and will be the first step towards a broad yield-sharing strategy.

Aave will also allow the net excess protocol income to be redistributed to token stakers, but it must meet specific conditions. As a result, the Aave protocol will launch a continuous eight-digit buyback plan, which will scale up as the protocol continues to grow.

Aave is expected to achieve significant growth

Aave has several growth drivers in the future, and with its current advantageous position, it is expected to benefit from the long-term growth trend of cryptocurrency as an asset class. From a fundamental perspective, Aave has multiple avenues for revenue growth:

Aave v4

Aave V4 will further enhance its competitiveness, helping to attract the next wave of billion users to Decentralized Finance. First, Aave will focus on revolutionizing the interactive experience of DeFi by building a unified liquidity layer. Second, Aave will improve the platform's accessibility by expanding to more chains and introducing more asset classes.

These developments ultimately gave rise to the Aave Network, which will become the central hub for stakeholders to interact with the Aave protocol. Given that the Aave Network will be developed as an L1 or L2 network, we expect the market to revalue its tokens to reflect the value of this new infrastructure layer.

Growth is positively correlated with the growth of BTC and ETH as asset classes.

This year, the launch of Bitcoin and Ethereum ETFs marks an important watershed in the popularization of cryptocurrencies. By lowering the participation threshold, these ETFs are expected to attract substantial capital from both institutions and retail investors, further integrating digital assets into mainstream portfolios.

For Aave, the overall growth of the crypto market is a positive factor, as over 75% of its asset composition consists of non-stable assets (mainly Bitcoin and Ethereum derivatives). Therefore, the growth of Aave's TVL and revenue is directly related to the growth of these assets.

Linked to the growth of stablecoin supply

In the future, Aave is expected to benefit from the growth of the stablecoin market. As the signals for global central banks entering a rate-cutting cycle become increasingly clear, the opportunity cost for investors seeking sources of yield will decrease. This may encourage capital to flow out of traditional financial yield instruments and into stablecoin farming in the DeFi space for higher returns. Additionally, in a bull market, the risk appetite of investors increases, and risk-taking behavior becomes more common, further stimulating stablecoin lending activities on platforms like Aave.

Summary

We are optimistic about Aave's prospects as a leading player in the rapidly growing field of Decentralized Finance. We believe that, with strong network effects and excellent token liquidity and composability, Aave will continue to solidify and expand its market dominance. The upcoming tokenomics upgrade will further enhance the protocol's security and improve its value capture capabilities.

In recent years, the market has generalized all DeFi protocols and priced them as an asset class with limited growth potential. This phenomenon can be seen from Aave's steadily rising TVL and revenue while its valuation multiple has fallen contrary to the trend. We believe this mismatch between valuation and fundamentals will not last long. AAVE currently offers excellent risk-adjusted investment opportunities in the crypto industry.