A Financial institution of Canada employees paper discovered that Aave V3 reported zero non-performing loans in 2024, with overcollateralization and automatic liquidations serving to forestall lender losses in its Ethereum lending market.
Utilizing transaction-level knowledge from Jan. 27, 2023, to Could 6, 2025, the study discovered that positions had been sometimes liquidated earlier than collateral values fell beneath excellent debt, serving to comprise lender losses throughout the pattern.
However the mannequin got here with a tradeoff, the paper mentioned. Whereas it protected lenders from unrecovered losses, it additionally shifted danger onto debtors and constrained capital effectivity in contrast with conventional lending methods.
In accordance to the paper, Aave V3’s design depends on automated danger controls relatively than conventional underwriting, requiring debtors to publish extra collateral than they borrow and liquidating positions after they breach danger thresholds.
Recursive leverage fueled borrowing demand
In accordance to the paper, Aave V3’s lending exercise was not pushed solely by customers searching for liquidity. It discovered that recursive leverage accounted for over 20% of whole borrowed quantity and eight.2% of borrowing transactions through the pattern interval.
Recursive leverage includes repeatedly borrowing in opposition to collateral, redeploying the borrowed belongings as new collateral and borrowing once more to amplify publicity.
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The examine mentioned the dynamic made debtors extra uncovered when markets turned. In accordance to the paper, liquidations on Aave V3 tended to happen in concentrated waves, with 4 belongings accounting for 90% of whole liquidated worth.
This contains Wrapped Ether (WETH), Wrapped Staked Ether (wstETH), Wrapped Bitcoin (WBTC) and Wrapped eETH (weETH).
The paper estimated that borrower losses throughout major liquidation events could possibly be important. It mentioned liquidation charges sometimes ranged from 5% to 10% of liquidated worth, whereas missed positive factors from subsequent value recoveries pushed mixed losses to about 10% to 30% in some instances.
The employees paper advised that whereas the design for Aave V3 helped forestall unrecovered dangerous debt within the pattern, it did so by exposing debtors to abrupt losses when collateral costs fell sharply.
Cointelegraph reached out to Aave for remark however didn’t obtain a response earlier than publication.
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