Aave V4: A Major Innovation in Decentralized Finance Lending Protocol

As one of the important cornerstones of the DeFi ecosystem, any movement of Aave attracts significant attention from the industry. Recently, Aave founder Stani officially announced at the ETHCC conference that the team is about to launch a new generation of important iterative version - Aave V4.

This upgrade is not just a simple routine update, but a key milestone in Aave's 2030 long-term strategic roadmap. The upgrade was first proposed in May 2024, with the core goal of systematically addressing the limitations exposed during the operation of the V3 version, particularly making 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 the content of Aave V4 in detail, review its evolution, analyze the 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 each other's counterparties, but the process of finding matching counterparts was slow and filled with uncertainty. After recognizing these fundamental flaws, the team upgraded the brand to Aave (i.e., AAVE V1) in September 2018, decisively shifting from the P2P model to a liquidity pool-based Point-to-Contract (P2C) model, where funds were pooled together to enable instant lending. The subsequent Aave V2 further reduced transaction costs 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 the assets deposited and borrowed by users are highly correlated (for example, between stablecoins, or between ETH and stETH), E-Mode allows users to unlock 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. The collateral provided under isolation mode can only be used to borrow a set 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 architecture cannot flexibly respond to the demands of emerging markets and diversified scenarios. For example, 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 squeezed into the existing smart contract framework.

This is the core problem 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 called the "Liquidity Hub + Spoke" model. This architecture is a direct response to the limitations of the "single entity" concept, which can be understood through a simple analogy in traditional finance: a central bank and its network of commercial banks.

• Liquidity Hub: Aave's "central bank"

On each blockchain network operated by Aave, there is 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 provide "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 fundamentally supported by a certain cross-chain interoperability protocol.

• Spoke: Aave's "specialized commercial bank". The liquidity center operates in the background, and users will 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 function like specialized commercial banks. For example, there may be:

  • Core Spoke: A general lending solution for handling low-risk, high-liquidity blue-chip crypto assets 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 special interest rate models 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 obtain 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, Sky. Sky has recently undergone a rebranding and launched its own "Endgame" plan. Both adopt a modular architecture, which marks the entire industry moving towards a more flexible and scalable design direction.

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 (now USDS, originally DAI). It establishes the most fundamental rules, maintains the stability of USDS, and serves as the ultimate guarantee of credit and security.

• SubDAO is a semi-independent specialized organization operating within the Sky ecosystem, playing the role of a "commercial bank" targeted at specific fields. The core work of SubDAO is asset management and risk assessment. They are authorized by the Sky Protocol to receive specific types of collateral and initiate requests to Sky Core for the minting of USDS.

The similarities between Aave's "Liquidity Hub + Spoke" and Sky's "Sky Core + SubDAO" are evident: both recognize that a single entity cannot meet all market demands, and therefore 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.

differences

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

First, there are 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 its predecessor, and its core strategy has always revolved around the issuance, stabilization, and promotion of its native stablecoin USDS. 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 granted a high degree of economic sovereignty, allowing each SubDAO to issue its own governance tokens, which enables it to build independent economic models, implement its own incentive programs, and directly capture the value created by its own business growth.

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 departments under a large group; they operate under the unified Aave brand and economic framework, and the value created also flows 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.

Integration of 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 come with unique legal and compliance requirements, making it difficult to manage them within a single, large protocol. The modular architecture of Aave V4 and Sky is well-suited for this, allowing the protocol to create independent, customizable, and even permissioned "sandbox" environments (such as RWA Spoke or RWA SubDAO) specifically designed to accommodate and manage RWA while maintaining its core decentralized and permissionless characteristics.

The Rise of Application Chains

A logical endpoint of this modular evolution is that major protocols will launch their own dedicated blockchains, known as "Appchain". Aave and Sky have both announced plans to develop in this direction, with Aave Network and NewChain respectively.

Having its own application chain means that the protocol can fully control its execution environment, customize the fee market, capture the MEV that would otherwise be taken by public chain miners or validators, and provide users with a smoother and more integrated experience. More importantly, using the native token as Gas and staking assets creates a value capture flywheel that is more powerful and direct than merely collecting interest shares. This marks the protocol's identity transformation from "tenant" (operating on Ethereum or L2) to "landlord" (owning its own sovereign platform).

impact on Ethereum

Although these application chains seem to be "leaving" Ethereum, in reality, their design relies on Ethereum. Aave Network and NewChain both plan to use Ethereum as their ultimate security and settlement layer. This reflects a broader shift in Ethereum's role—from a place where all activities occur to a foundational trust layer that provides security for a vast interconnected chain ecosystem.

However, this shift also presents severe challenges to Ethereum's economic model. Historical experience shows that when the activities of major protocols migrate to Layer 2, the transaction volume on the Ethereum mainnet decreases, leading to a reduction in fee income. The decrease in Base Fee burn will weaken ETH's deflationary mechanism, exposing it to inflationary pressures.

Therefore, in the face of the major trend of DeFi protocols independently becoming chains, Ethereum must actively evolve and explore new economic models that can effectively capture value from its new role as an "ecosystem security provider" in order to maintain the healthy operation of the entire ecosystem.

Conclusion

Aave V4 is not just an upgrade, but a strategic repositioning. It is a thoughtful solution to the internal challenge of "a single entity cannot meet diverse needs" and a forward-looking response to external opportunities such as RWA and multi-chain landscapes.

By transforming into a modular open platform, Aave is laying the groundwork for becoming the infrastructure of the next generation of on-chain finance, going beyond simple lending applications. The "Liquidity Hub + Spoke" model brings users greater capital efficiency and provides developers with unprecedented flexibility. This evolution resonates with the movements of its main competitors and signifies that the DeFi industry is maturing, preparing for broader adoption and more complex financial integrations. The launch of Aave V4 will be a key event to watch, as it has the potential to set new standards in the DeFi lending space in the coming years.

This article is based on publicly available information and does not constitute investment advice. Cryptocurrency investments carry significant risks, please make your decisions cautiously.