Aave's evolution: from a dual-layer market to a liquidity ecosystem hub

Aave is restructuring its core architecture. With the advancement of version 4, this DeFi lending giant is evolving from a simple dual-market structure into a true on-chain capital market infrastructure.

Current Situation: Deep Liquidity Attracts Institutional Interest

Aave’s TVL has hit a record high, and this is no coincidence. As one of the earliest lending protocols in the industry, its core competitiveness stems from liquidity depth—precisely what high-net-worth users and institutional investors value most. The Ethereum Foundation depositing 30,800 ETH into Aave in February 2025 fully validates this point: only on platforms with sufficient liquidity can large capital inflows avoid causing drastic interest rate fluctuations.

Currently, Aave is deployed on 19 public chains, but liquidity is not evenly distributed. Over 80% of liquidity remains concentrated on Ethereum, reflecting the protocol’s focus on the most secure and stable mainnet. In Layer 2 scaling ecosystems, Arbitrum ranks first, followed by Linea and Base—these chains host a growing number of active users.

Beyond traditional lending markets, Aave has officially entered the RWA (Real-World Asset Tokenization) sector through the Horizon market, with a current scale of about $600 million. This market accepts tokenized money market funds issued by entities like Superstate and Centrifuge as collateral, organically linking traditional finance and DeFi user groups.

Design Logic of the Dual-Market Structure

Aave v3 introduces a dual-market architecture that cleverly balances efficiency and security. Prime Market focuses on high capital efficiency, supporting only blue-chip assets, with the core mechanism being Efficiency Mode (E-Mode), allowing highly correlated assets (such as wstETH and WETH) to be borrowed at 95% LTV, with a liquidation threshold of 96.5%, and a current scale of about $1.17 billion.

Core Market is even larger, exceeding $42 billion in scale, supporting a wide range of asset classes. It enhances risk isolation through Isolation Mode, setting exposure limits and more conservative borrowing ratios (usually below 85%) for high-risk assets.

This layered design ensures system resilience but comes at the cost of liquidity fragmentation—funds in Prime and Core cannot flow freely, resulting in capital efficiency loss.

Risk Management: Multi-Layer Defense for Protocol Security

Aave’s security is built on multiple coordinated mechanisms. First, all core parameters (LTV, liquidation thresholds, lending switches, interest rate models) are governed by DAO, allowing the protocol to adapt flexibly to market changes.

Second, the Umbrella system (formerly Safety Module) provides critical safeguards: users stake aToken or GHO to earn rewards, serving as a source of compensation in case of bad debts. The DAO has committed to an initial bad debt protection of $100,000.

Finally, liquidation mechanisms continuously monitor each lending position via the health factor (HF). When HF drops below 1, the system triggers liquidation, where liquidators can repay up to 50% of the debt and acquire collateral at a discount, maintaining the protocol’s solvency.

v4: Liquidity Hub and Modular Future

Aave v4 has restructured its core to address key pain points. Liquidity Hub aggregates liquidity from Prime and Core into a unified fund pool, enabling funds to dynamically flow based on market demand, significantly improving capital efficiency.

Spokes Mechanism allows independent market instances to operate with their own parameters—supporting long-tail assets, custom supply and borrow limits—while being constrained by the Hub’s system rules. This modular design lays the foundation for future vertical expansion of the protocol.

The newly launched Aave App targets retail users, offering up to 6.5% annual yield and up to $1 million balance protection. The app also includes built-in on/off ramp services, further lowering the barrier for new users to enter DeFi.

Consolidating the On-Chain Banking Role

Aave is continuously strengthening its role as an “on-chain bank” through modular architecture, RWA market expansion, and industry-leading liquidity barriers. The launch of v4 marks the protocol’s evolution from a simple lending platform to a multi-layered capital market infrastructure—serving large institutional capital needs and providing user-friendly financial tools for retail users.