Aave V4: Redefining the Future of Decentralized Finance Lending Protocols

As one of the core components of the DeFi ecosystem, Aave, as the largest and most mature lending protocol, has attracted significant attention from the industry. Recently, at the ETHCC conference, the founder of Aave officially announced the upcoming launch of the next important iteration version - Aave V4.

Aave V4 is not just a simple routine upgrade, but a key milestone in Aave's long-term strategic roadmap. This upgrade was first proposed in May 2024, with the core goal of systematically addressing the limitations exposed during the operation of V3, particularly breakthroughs in key areas such as scalability and risk management. Through this far-reaching update, Aave aims to fundamentally reshape the underlying architecture and core functions of the Decentralized Finance lending protocol, preparing for the future development of the protocol.

This article will explore in detail the contents included in Aave V4. We will review its evolution, analyze its new architecture, and interpret these changes in the context of broader trends in the Decentralized Finance industry.

The Evolution of Aave

Aave's journey began with ETHLend, a P2P platform where lenders and borrowers needed to find their counterparties. However, the process of finding matching counterparts was slow and fraught with uncertainty. After the team deeply recognized these fundamental flaws, they upgraded the brand from ETHLend to Aave (i.e., AAVE V1) in September 2018, decisively shifting from a P2P model to a liquidity pool-based Point-to-Contract (P2C) model, where funds were pooled together for instant lending. Subsequently, Aave V2 further reduced transaction costs on the congested Ethereum network by optimizing smart contracts, allowing more people to access Decentralized Finance.

The current version Aave V3 has made significant strides in capital efficiency and risk management compared to version V2. It introduces several key features, such as:

• Efficient Mode (E-Mode): When the prices of assets deposited and borrowed by users are highly correlated (for example, between stablecoins, or between ETH and stETH), E-Mode allows users to unlock a higher borrowing capacity (such as a higher LTV). This directly addresses the issue of insufficient capital efficiency for correlated assets in V2.

• Isolation Mode (Isolation Mode): Allows new, higher-risk assets to be launched in an "isolated" manner. Collateral provided in isolation mode can only be used to borrow a group of governance-approved stablecoins, with a clear debt limit, and cannot be mixed with other collateral. This effectively "isolates" the risk of new assets, preventing risk contagion.

However, Aave V3 also exposes a deeper strategic limitation: a single entity structure cannot flexibly respond to the demands of emerging markets and diverse scenarios. Imagine a traditional bank that initially accepts only real estate as collateral. All its forms, processes, and risk assessment models are designed around real estate. Now, a client wants to apply for a loan using their company's equity, patent rights, or even future accounts receivable. The bank will find that its original "one-size-fits-all" process is completely unable to handle these new types of assets with different risk characteristics. The bank can either undergo a painful internal reform or give up on these new businesses.

Aave V3 is facing a similar dilemma. Its core smart contracts are tailored for crypto-native assets (such as ETH, WBTC, stablecoins). When the industry begins to introduce RWA, such as tokenized government bonds or private credit as collateral, Aave V3's single architecture becomes inadequate. RWA involves off-chain legal compliance, counterparty risk, and different liquidation logic, which cannot simply be accommodated within the existing smart contract framework.

This is the core issue that Aave V4 aims to fundamentally address: how to evolve from a single rigid product into a flexible platform that can support countless financial scenarios.

Aave V4: Modular New Architecture

Aave V4 introduces a brand new design known as the "Liquidity Hub + Spoke" model. This architecture is a direct response to the limitations of a "single entity", and we can understand it with a simple analogy from traditional finance: a central bank and its network of commercial banks.

• Liquidity Hub: Aave's "Central Bank"

On each blockchain network running Aave, there will be a unified Liquidity Hub that aggregates all assets supplied by users. This hub serves as the central liquidity source for the entire network. It does not directly offer "retail" services to end users. Instead, it focuses on macro liquidity management and risk control, providing stable and deep liquidity for the entire ecosystem. This model is expected to improve capital utilization, bring higher returns to lenders, and offer lower interest rates to borrowers.

Liquidity centers on different chains are not isolated; they can efficiently communicate and transfer liquidity with each other. This is mainly achieved through a mechanism called "Unified Cross-Chain Liquidity Layer (CCLL)", which is supported by the core technology of Chainlink's Cross-Chain Interoperability Protocol (CCIP).

• Spoke: Aave's "specialized commercial bank"

The liquidity center operates in the background, and users interact with the protocol through various Spokes. Spokes are user-facing, modular lending markets, each designed for a specific purpose and connected to the central liquidity center. They are akin to specialized commercial banks. For example, there might be:

• Core Spoke: A general lending mechanism used for handling blue-chip crypto assets with low risk and high liquidity, such as ETH and WBTC.

• E-Mode Spoke: Specifically optimized for stablecoins, LST, and other highly correlated currency pairs, providing the highest capital efficiency.

• RWA Spoke: Tailored for tokenized treasury bonds, real estate, and other real-world assets. This type of Spoke can integrate stricter access, custody, or compliance rules to meet institutional and regulatory requirements.

• A high-leverage trading Spoke, designed for professional traders seeking high risk and high returns, featuring a special interest rate model and risk control parameters.

The most important aspect of this design is its openness. Aave V4 will allow developers to build and propose their own Spoke. If a new Spoke design passes Aave's governance approval, it can receive a line of credit from the liquidity hub, thereby leveraging Aave's vast liquidity network to launch a new, specialized market. This fundamentally transforms Aave from a mere product into a foundational platform for financial innovation.

Comparison: Aave VS. Sky (formerly MakerDAO)

To fully understand Aave's strategic direction, it would be helpful to compare it with its main competitor MakerDAO. MakerDAO has recently undergone a rebranding, changing its name to Sky and launching its own "Endgame" plan. It can be said that "great minds think alike"; Sky has also adopted a modular architecture, marking a shift in the industry towards more flexible and scalable design.

similarities

The architecture of Sky can be described as "Sky Core + SubDAO".

• Sky Core plays the role of a "central bank" in the Sky ecosystem, inheriting the function of issuing stablecoins from MakerDAO (now USDS, formerly DAI). It establishes the most fundamental rules (for example: approving which SubDAOs can access the system, the total minting cap for each SubDAO, emergency shutdown mechanisms, etc.), maintains the stability of USDS, and serves as the ultimate credit and security guarantee.

• SubDAO is a semi-independent specialized organization operating within the Sky ecosystem, serving as a "commercial bank" focused on specific fields. The core responsibilities of SubDAO include asset management and risk assessment. They are authorized by the Sky Protocol to accept specific types of collateral and initiate a minting request for USDS to Sky Core. For example, the Spark Protocol is currently the only mature SubDAO in the Sky ecosystem, which focuses on lending and is a direct competitor of Aave. Other SubDAOs may focus on RWA assets or other niche markets.

The similarities between Aave's "Liquidity Hub + Spoke" and Sky's "Sky Core + SubDAO" are apparent: both recognize that a single entity cannot meet all market demands, and thus adopt the model of "central bank + specialized commercial banks": the central bank formulates policies and provides liquidity, while specialized commercial banks are responsible for developing specific business scenarios.

Looking back at the grievances between Aave and Sky (MakerDAO), Sky Spark was born from directly forking the open-source code of Aave V3. The two parties also had a fierce dispute over the profit-sharing protocol, with Aave accusing Spark of failing to pay the promised 10% profit share. Now, Aave V4 has only "borrowed" from Sky's mature modular design concept, which can be seen as "treating others as one wants to be treated oneself."

Differences

Despite their similarities, Aave and Sky also have significant differences in core business, economic models, and ecological sovereignty.

First, let's discuss the types of liquidity: Aave's Liquidity Hub aims to provide liquidity for a wide range of asset classes, including stablecoins, volatile assets (such as ETH), and derivative assets (LSTs), among others. Sky inherits the genes of MakerDAO, and its core strategy has always revolved around the issuance, stabilization, and promotion of its native stablecoin USDS (formerly DAI). The main task of its SubDAO is to create more application scenarios and demand for USDS, deepening its liquidity moat.

Secondly, there is the economic model and sovereignty: this is the most fundamental difference between the two. The Sky SubDAO is endowed with a high degree of economic sovereignty, and each SubDAO is allowed to issue its own governance token (such as Spark's SPK token), which enables it to build an independent economic model, implement its own incentive programs, and directly capture the value created by its own business growth. This economic independence allows SubDAOs to evolve complex and powerful functional architectures. Taking Spark, the only mature example in the current Sky ecosystem, as an example, its operating model can be likened to a dual-layer financial system:

1. At the level of "commercial banks" ( retail end ): It has a lending platform for end users called Spark Lend. This part of the business directly serves individual users, functioning similarly to the commercial banks we are familiar with.

2. At the level of "Regional Reserve Bank" ( wholesale end ): Spark also has a liquidity layer called Spark Liquidity Layer (SLL), which acts as a regional "liquidity hub". After obtaining liquidity (such as USDC/USDS) from Sky Core, SLL not only provides funding support for its own "commercial bank" Spark Lend, but also "wholesales" this liquidity to other Decentralized Finance protocols, such as Morpho, and even competitors like Aave.

Therefore, Spark is not just a simple lending application, but a deeply integrated liquidity engine that combines retail and wholesale business, fully utilizing its identity as a SubDAO to create and distribute value both within and outside the Sky ecosystem.

In contrast, the independence and autonomy of Spokes in Aave V4 are much weaker. Currently, Spokes cannot issue their own tokens. They are an extension of the Aave core protocol, and the value they generate (such as interest income) will flow back to the Aave DAO. A Spoke is similar to different divisions under a large group, operating under a unified Aave brand and economic framework, with the value created also flowing back to the group headquarters.

Macroscopic Perspective

The architectural changes of Aave and Sky are not isolated events but are a direct response to the major trends shaping the future of Decentralized Finance.

Integrate RWA

The next frontier of DeFi growth is widely considered to be the tokenization of real-world assets, such as government bonds, real estate, and private credit. These assets have unique legal and compliance requirements, making them difficult to manage within a single, large protocol. The modular architecture of Aave V4 and Sky is very suitable for this, allowing protocols to create independent, customizable, and even permissioned "sandbox" environments (such as RWA Spoke or RWA SubDAO) specifically designed to hold and manage RWAs while maintaining their core decentralized and permissionless characteristics.