The price of the coin doubles, TVL returns, reinterpreting the early recovery of the established leader Aave

Author: Green Light Capital

Compiled by: Azuma, Odaily Planet Daily

Editor’s Note: The lending leader Aave (AAVE) has shown a reverse trend independent of the weak performance of the sector over the past few months. While the tokens of many established DeFi protocols have remained stagnant, the price of AAVE has quietly doubled—from around $80 on August 5 to over $170 now.

With the Federal Reserve officially entering a rate-cutting cycle, discussions about the return of the "altcoin season," especially the call for "DeFi to rise again," have become increasingly prominent, and Aave seems to have taken the lead in recovery. In the following article, Green Light Capital reanalyzes Aave's current fundamental situation from multiple dimensions, which may help investors clarify the logic behind AAVE's rise and expectations for future trends.

Below is the full content from Green Light Capital, compiled by Odaily Planet Daily.

Why AAVE May Dominate in This Bull Market?

The DeFi space may seem daunting at first glance; it is often viewed as the most challenging part of the crypto industry to understand. Compared to the latest projects with innovative value propositions, it is often considered less attractive.

However, the reality is quite the opposite. Despite a decline in interest in the DeFi space following the collapses of Terra Luna and Celsius, some protocols are now offering the best investment opportunities in the industry.

Today, we will further explore this topic through an analysis of Aave, hoping it can help you understand all the necessary information before making investment decisions.

Overview of Aave

Aave started in 2017 (formerly known as ETHLend) and quickly developed into a leading project in the DeFi space. As a lending platform, Aave primarily offers a trustless, transparent, and secure traditional financial proposal solution.

°How does it work?°

For 80% of Aave users, the protocol is mainly used to provide liquidity. They can connect their wallets, deposit ETH, stablecoins, or other crypto assets, and earn returns on these deposits. Most users' experience ends here, with their earnings coming entirely from borrowers of the borrowed assets—borrowers must pay interest as a return for borrowing. The interest is redistributed to all deposit users after deducting a fee known as the "reserve factor," with the deducted fees going to Aave DAO.

To borrow assets on Aave, users must provide collateral. Typically, borrowers will deposit assets such as BTC, WBTC, or ETH, or deposit assets related to ETH, like stETH or $WETH, while borrowing stablecoins. When users expect the value of BTC or ETH to rise, they are more inclined to adopt this strategy, as it allows them to repay the loan at a lower cost. However, if the value of the collateral sharply declines due to unexpected market events and is no longer sufficient to cover the debt, liquidation occurs. In this case, liquidators will repay the debt on behalf of the borrower in exchange for a portion of the collateral as a reward. This liquidation process protects the entire protocol while ensuring the safety of liquidity providers' assets.

Considering that liquidators may not be able to cover all losses, Aave has also set up a "safety module" consisting of $500 million worth of AAVE tokens. This module is supported by users who voluntarily collateralize their AAVE or provide liquidity in AAVE and ETH as a reward for safe behavior, acting as a second line of defense to protect the protocol in black swan events.

Key Catalysts for AAVE

In this next section, we will focus on the key catalysts that are expected to help AAVE surpass other altcoins in the current cycle.

Catalyst 1: Paradigm Shift—Stakers Will Share Protocol Revenue

On July 25, 2024, Marc Zeller (Aave Integration Lead) proposed a plan called "AAVEnomics Update," aimed at implementing a "buy and distribute" program. This plan hopes to directly reward DAO participants with the protocol's excess revenue. This marks a significant shift in AAVE's tokenomics, enhancing AAVE's appeal by providing tangible financial benefits to holders.

Interested readers can learn about this governance proposal that could fundamentally change everything for AAVE through this article.

Catalyst 2: Partnership with BlackRock

Aave has proposed to integrate BlackRock's tokenized fund BUIDL into its GHO stablecoin module (GSM).

The plan aims to utilize idle USDC to mint BUIDL, which is backed by physical assets such as U.S. Treasuries and cash managed by BlackRock, thereby improving capital efficiency. This not only enhances GHO's reserve management capabilities but also increases liquidity within the Aave ecosystem. The BUIDL token generates daily dividends, providing participants with stable returns while diversifying Aave's revenue sources—adding RWA exposure.

Additionally, this integration can utilize a $100 million USDC redemption fund supported by Circle to achieve seamless exchanges between GHO and USDC, thus responding more effectively to market demand fluctuations and enhancing GHO's stability as a stablecoin.

By partnering with global financial giant BlackRock, Aave can not only strengthen its reputation but also reposition itself as a pioneer in the integration of traditional finance and DeFi, opening doors for future institutional collaborations.

This partnership also plays a crucial role in achieving the key milestones required for Aave's revenue distribution proposal:

• GHO supply must reach 175 million: By utilizing idle USDC to mint BUIDL, the increase in revenue enhances the demand for GHO, increasing the likelihood of GHO surpassing a circulating supply of 175 million.

• Absorbing large GHO sales with minimal slippage: The USDC redemption fund ensures that large GHO sales (such as a $10 million exchange) can be executed with minimal slippage (1% price impact), maintaining GHO's stability.

Catalyst 3: Expansion to Solana

For months, Aave has hinted at expanding to Solana.

Marc Zeller mentioned that his role is to help Aave DAO maximize profits, which means they must operate flexibly and explore various ways to increase protocol revenue. Aave's view on Solana has changed since the FTX collapse. As a data-driven platform, Aave will only propose migration plans if the potential revenue on Solana exceeds the costs of modifying code and conducting security audits.

Currently, the potential revenue on Solana is not yet sufficient to justify this migration, but Marc pointed out that the situation is gradually improving, and Solana is becoming increasingly attractive. Aave is monitoring its development.

Aave believes that expanding to Solana is not difficult, and with their influence, they can quickly establish a leading position on that network.

Catalyst 4: Leading Position & Brand Reputation

In recent years, due to the collapses of FTX and Terra Luna, repeated hacks of DeFi protocols, and ongoing wallet thefts, DeFi users and the broader crypto community have become increasingly risk-averse.

As a result, users find it increasingly difficult to trust decentralized DeFi protocols to manage their assets. In this ecosystem, brand reputation plays a crucial role in gaining investor trust. This is Aave's greatest advantage and the reason we believe new protocols will find it difficult to surpass Aave in the coming years. Since 2017, Aave has been an integral part of the DeFi ecosystem. Although it has encountered some minor security incidents, they have primarily been related to external smart contracts or liquidity pool issues, and it has never suffered a major hack that directly jeopardized its core protocol. Aave has been proactive in addressing security issues, conducting multiple audits, and running a bug bounty program to incentivize vulnerability identification.

Therefore, Aave is considered one of the safest DeFi platforms, with its clients primarily being whales who seek attractive returns while lending funds. These whales prioritize security and are unlikely to move assets to newer, less battle-tested protocols just for slightly higher returns. As institutional participants increasingly enter DeFi, Aave is fully capable of maintaining its leadership position.

With a 67% market share in the lending space, Aave is expected to continue strengthening its dominance in the coming years, solidifying its position as a market leader.

Market Outlook Analysis

As you know, borrowing on Aave requires collateral. Therefore, we have been looking for lending models in traditional finance that align with Aave's business for comparison and to highlight the significant growth potential of DeFi in the coming years.

In our analysis, margin loans seem to be the most similar to Aave's lending model, as they allow stock market investors to use existing assets as collateral to borrow money to purchase more stocks/securities.

On Aave, borrowers are typically individuals who believe that the crypto market will continue to rise. They usually use assets like BTC and ETH as collateral to borrow stablecoins to buy more cryptocurrencies. If the market rises, their borrowing costs decrease, allowing them to profit from trades. However, if the market falls, they also face margin calls and potential liquidation risks, similar to the risks faced by margin loan users in traditional finance.

Upon closer analysis of active loans in DeFi, it is evident that the sector is recovering and is expected to return to the historical peak (ATH) of approximately $20 billion last seen in 2021. Currently, there are $11 billion in active loans within the cryptocurrency space, with $7.4 billion coming from the Aave protocol, further highlighting its market dominance. However, compared to the current total of $800 billion in margin loans in traditional finance (a difference of up to 80 times), it is clear that there is significant growth potential in the crypto lending market in the coming years.

Valuation Comparison

The best way to assess whether an asset is overvalued or undervalued is to use key metrics such as market cap/TVL multiples to compare it with other assets. We conducted this analysis a few weeks ago, and the results show that AAVE is currently significantly undervalued.

In this post, you can also find our predictions for price and market cap over the next 12 months.

Token Economic Model

Aave's token was first launched under the name LEND during the ETHLend era. In 2020, Aave introduced a token swap that significantly reduced the maximum supply of tokens.

Through this swap, holders were able to exchange 100 LEND tokens for 1 AAVE token, reducing the total supply from 1.3 billion LEND to 13 million AAVE. Additionally, the team allocated an extra 3 million tokens to the Aave ecosystem reserve to support protocol development.

The migration from LEND to AAVE marked the introduction of an internal governance mechanism, allowing the community to submit Aave Improvement Proposals (AIPs) and participate in the project's development. Governance thus became a core utility of the AAVE token.

The initial distribution structure of the AAVE token is as follows.

Financing and Unlocking Status

In 2017, the Aave team conducted an initial coin offering (ICO), raising $16.2 million from investors at a price of $0.0184 per LEND token (equivalent to $1.84 per AAVE token). As of today, these investors have achieved a 78-fold return on their investment, with returns as high as 360 times during AAVE's all-time high (ATH). However, given that this was seven years ago, it is unlikely that many initial investors still hold their tokens.

During the 2020 token swap, Aave also completed several rounds of financing. These rounds primarily involved selling tokens from the Aave treasury, raising $32 million in funds. Unfortunately, specific details about these financing rounds (such as unlocking schedules) have not been disclosed. It is speculated that most VCs may have sold their holdings during the bull market in 2021, so the risk of these institutions massively dumping AAVE again is low.

In terms of unlocking status, as of now, the circulating supply of AAVE is 14.9 million, accounting for the vast majority of the total supply of 16 million tokens. Additionally, about 1 million tokens remain in the treasury for staking rewards in the safety module and to incentivize liquidity providers. Since most AAVE tokens are already in circulation, there will not be large-scale token unlocks in the future, ensuring that AAVE will not face significant value dilution.

This is the best token structure, with almost all tokens already in circulation.

Token Utility

Currently, the utility of the AAVE token is relatively limited and can be summarized into two main aspects. The first is governance utility, where AAVE holders can vote on proposals or initiate new proposals (AIPs) that can affect the protocol's risk parameters, incentives, product improvements, and upgrades; the second is staking utility, where AAVE holders can choose to allocate tokens to the safety module. When black swan events occur, the staked tokens will be slashed by the protocol to repay remaining debts, protecting liquidity providers' assets—AAVE stakers will receive corresponding incentives as a reward for protecting the protocol's safety.

As new revenue distribution proposals progress, the utility of AAVE will also change. The most significant change will be the transition of the current safety module to a "legacy safety module," meaning that the existing system—where staked AAVE may be slashed in extreme cases to cover protocol deficits—will evolve into a more efficient and user-friendly model.

Under the new model, the staking mechanism of AAVE tokens will be decoupled from protocol security responsibilities. AAVE holders can still stake their tokens for income rewards, but these rewards will be directly tied to the protocol's revenue rather than associated with protocol risk. This means that the staking risk of suffering losses due to protocol security events will be eliminated, making staking more attractive to token holders.

K-Line Analysis

From a technical perspective, AAVE's outlook in the coming months appears quite attractive, especially considering its strong performance relative to BTC and ETH in recent weeks.

When analyzing the AAVE/ETH trading pair, we observe that the trend on the weekly timeframe has changed significantly. AAVE has successfully set new highs, indicating a potential trend reversal or suggesting that the downward trend associated with the bear market may have passed. In our view, the bottom for AAVE relative to ETH is likely already established.

When analyzing AAVE's movements alone, we can see that the token has finally broken out of the weekly consolidation range that began in May 2022. The token seems to be regaining strength and attracting more investor interest, especially after announcing the distribution of excess revenue to token holders.

After such a long accumulation period, we expect AAVE to rapidly reprice and then enter a positive upward trend.

Investment Notes

Based on our analysis, AAVE seems to be an obvious choice in the current bull market. The new revenue distribution plan fundamentally changes AAVE's value capture ability, linking the interests of token holders with the earnings of the Aave protocol.

The lending market in DeFi is still small, but it may experience significant growth in the coming years, especially as more institutional participants gradually enter the space. With its strong brand reputation and leading position, Aave has the ability to absorb these new inflows of capital and is expected to horizontally expand into more new markets (such as Solana).

Additionally, by comparing the "market cap/TVL" ratio, it can be seen that although AAVE has recently risen significantly, its price is still undervalued.

AAVE has recently broken out of a year-long trading range, and given its current undervalued state, we expect the market to reprice it soon.