Detailed Explanation of AAVE V4 Upgrade: Reshaping Lending with Modularity, Can Old Coins Welcome a New Spring?

This V4 update may allow us to see the future strong competitiveness of AAVE in the field of DeFi and the root cause of its rising business volume. (Synopsis: From Polygon to Morpho to WLFI: Aave has repeatedly become a “stepping stone”, and the DeFi gentleman’s agreement is like paper?) (Background added: MakerDAO’s Yang Strategy: Use your code, grab your market, is Spark a sword to Aave’s heart?) AAVE founder Stani’s announcement of the upcoming launch of AAVE V4 on the evening of August 25 quickly attracted a lot of attention and discussion, and the recent dispute between AAVE and WLFI over the 7% token distribution proposal has also stirred up in the market. For a while, the market’s attention converged on AAVE, a long-established lending agreement. Although the dispute between AAVE and WLFI has not yet reached a final conclusion, behind this “farce”, it seems to show a different scene - “flowing new coins, ironclad AAVE”. With the emergence of more and more new coins, AAVE undoubtedly has good fundamentals and catalysts, stimulated by the demand for fixed token lending on the chain. This V4 update may allow us to see its strong competitiveness in the field of DeFi in the future and the root cause of its rising business volume. From lending protocols to DeFi infrastructure When we discuss AAVE V4, we first need to understand a key question, why is the market expecting this upgrade? From ETHLend in 2017 to today’s $38.6 billion TVL DeFi giant, as a veteran protocol, AAVE has been optimized with each version update in the past, and can affect the liquidity and gameplay of on-chain assets to varying degrees. The version history of AAVE is actually the evolution of DeFi lending. At the beginning of 2020, when V1 went live, the entire DeFi lock-up volume was less than $1 billion. AAVE uses liquidity pools instead of P2P models, allowing lending to change from “waiting for matchmaking” to “instant execution”. This change helped AAVE gain market share quickly. V2 was launched at the end of 2020 with core innovations being flash loans and debt tokenization. Flash loans have spawned arbitrage and liquidation ecology, and have become an important source of income for the agreement. Debt tokenization allows positions to be transferred, paving the way for subsequent income aggregators. V3 in 2022 focuses on cross-chain interconnection, allowing more on-chain assets to enter AAVE and become a linker of multi-chain liquidity. What’s more, AAVE has become the pricing benchmark. DeFi protocols refer to AAVE’s supply and demand curve when designing interest rates. New projects will also benchmark AAVE’s quotes when selecting the mortgage rate. However, despite the infrastructure, the architectural limitations of V3 are becoming more and more obvious. The biggest problem is liquidity fragmentation. AAVE currently has $60 billion in TVL in Ethereum, Arbitrum has only 4.4 billion, and Base is even less. Each chain is an independent kingdom, and money cannot flow efficiently. This not only reduces capital efficiency, but also limits the development of small chains. The second problem is innovation bottlenecks. Any new feature requires a complete governance process, which often takes months from proposal to implementation. In the environment of rapid iteration of DeFi, this speed clearly cannot keep up with market demand. The third problem is that the demand for customization cannot be met. RWA projects require KYC, GameFi requires NFT collateral, and institutions need segregated pools. But V3’s unified architecture struggles to meet these differentiating needs. Either all or all not, there is no middle ground. This is the core problem that V4 solves: how to transform AAVE from a powerful but rigid product into a flexible and open platform. V4 Upgrade According to publicly available information, the core improvement direction of V4 is the introduction of the “Unified Liquidity Layer”, which adopts the Hub-Spoke model to change the existing technology design and even the business model. Image source @Eli5DeFi Hub-Spoke: Solving the problem of both and both Simply put, Hub brings together all the liquidity, and Spoke is responsible for the specific business. Users interact through Spoke forever, and each Spoke can have its own rules and risk arguments. What does this mean? This means that AAVE no longer needs to serve everyone with one set of rules, but can make different Spoke serve different needs. For example, Frax Finance can set up a dedicated Spoke, only accept frxETH and FRAX as collateral, and set more aggressive arguments; At the same time, an “institutional spoke” may only accept BTC and ETH, requiring KYC but offering lower interest rates. The two Spoke share the liquidity of the same Hub, but are isolated from each other’s risks. The beauty of this architecture is that it solves the “both want and want” dilemma. It is necessary to have both deep liquidity and risk isolation; It should not only be unified management, but also flexible customization. In the past, these were contradictory in AAVE, but the Hub-Spoke model allows them to coexist. Dynamic Risk Premium Mechanism In addition to the Hub-Spoke architecture, V4 also introduces a dynamic risk premium mechanism, which revolutionizes the way borrowing interest rates are set. Unlike V3’s uniform interest rate model, V4 dynamically adjusts interest rates based on collateral quality and market liquidity. For example, highly liquid assets such as WETH enjoy a base interest rate, while more volatile assets such as LINK pay an additional premium. This mechanism is executed automatically through smart contracts, which not only improves the security of the protocol, but also makes the cost of borrowing fairer. Smart Account V4’s Smart Account feature makes user operations more efficient. In the past, users needed to switch wallets between different chains or marketplaces, and managing complex parts was time-consuming and laborious. Smart accounts now allow multi-chain assets and lending strategies to be managed from a single wallet, reducing the number of steps. A user can adjust WETH collateral on Ethereum and borrowing on Aptos within the same interface, eliminating the need for manual cross-chain transfers. This simplified experience makes it easier for both small users and professional traders to participate in DeFi. Cross-chain and RWA: The extension suite DeFi Border V4 implements second-level cross-chain interaction through Chainlink CCIP, supports non-EVM chains such as Aptos, and allows more assets to seamlessly access AAVE. For example, a user can borrow money on Arbitrum with collateral for assets on Polygon, all in one transaction. In addition, V4 integrates real-world assets (RWAs), such as tokenized treasury bonds, opening up new paths for institutional funds to enter DeFi. This not only expands AAVE’s asset coverage, but also makes the lending market more inclusive. Market reaction While this week AAV…