Interpreting Aave V4: A Shift from Product to "Bank"

Original Title: “Decoding Aave V4: A Transition from Product to ‘Bank’”

Original Author: Eric, Foresight News

On the evening of March 30 Beijing time, the Aave V4 version, which was approved in 2024, officially launched on the mainnet, bringing the first good news since the Aave DAO governance debate.

V4 can be seen as a complete overhaul of Aave, with the core change being the integration of previously independent lending markets into a unified liquidity pool architecture: Hub and Spoke.

In V4, each chain or L2 has a single liquidity center (the Hub), where all assets deposited for lending are stored in a unified liquidity pool. The Hub is responsible for overall coordination, credit limit control, system-level constraints (such as “total borrowings ≤ total supply”), and emergency pauses. The Hub does not directly interface with users but manages liquidity centrally in the background.

It’s worth noting that each chain does not have only one Hub but designs different Hubs based on specific needs, which essentially serves as risk isolation. For example, V4 currently features Core Hub, Prime Hub, and Plus Hub. The Core Hub contains mainstream assets and is open to all users, while Prime Hub is designed for providers seeking more “controllable” collateral. Plus Hub is tailored for strategic stablecoins, with parameters considering the project’s scale.

As for Spoke, you can think of it as an independent market, each with its own lending functions, risk parameters, and collateral rules. Within a Hub, user assets are stored in the same liquidity pool, and borrowers select different Spokes based on their needs. For example, as shown in the diagram, users can deposit WETH as a borrowable asset, and borrowers can borrow WETH across the first four Spokes, but only EtherFi Spoke allows collateralization with weETH.

Although the official stance is that it can integrate fragmented liquidity, in practice, for users lending against high-quality collateral, the differences are minimal. For example, if you want to collateralize ETH to borrow assets, the operations in V3 and V4 are similar, as long as you keep the health factor from dropping too low.

Therefore, in terms of liquidity integration, V4 is indeed more refined than managing independent markets, but it’s not a qualitative leap. The real differences come from the customizable parameters of Spokes and the new liquidation engine.

In V4, a borrower’s interest rate depends on a base rate and a risk premium. The base rate still follows the utilization curve like in V3, rising slowly below the optimal utilization and sharply above it. The risk premium depends on the nature of the collateral; if the collateral is more stable assets like USDT, ETH, WBTC, the risk premium will be very small or zero. Conversely, high-risk tokens like altcoins will have a high risk premium to prevent “good assets subsidizing bad assets.”

For example, in V3, interest rates depend entirely on supply and demand. Borrowing USDT, for instance, the maximum LTV and liquidation thresholds may differ, but the interest rates for collateralized ETH and LINK are the same under the same supply-demand conditions. However, LINK’s higher volatility means its interest rate is more sensitive. If interest rates are equal, borrowers collateralizing LINK will push utilization higher, causing the borrowing cost for ETH collateral users to increase instead of decrease.

V4 addresses this flaw by requiring users borrowing high-risk assets to pay higher costs, while lenders can earn higher yields. Higher interest rates also limit borrowing demand, giving users collateralizing quality assets a cost advantage.

Regarding liquidation, liquidators will only restore the health factor to the Spoke’s preset target, and the lower the health factor, the higher the liquidation bonus. This design not only provides borrowers with more operational flexibility but also reduces the platform’s bad debt risk. Additionally, the new liquidation engine introduces a “dust protection mechanism,” where if remaining debt or collateral falls below a threshold (e.g., $1,000), the liquidator must fully close the position to prevent small residuals from reducing capital efficiency.

Finally, idle liquidity in the Hub can be automatically invested into low-risk yield strategies approved by governance (such as short-term government bonds, stablecoin LPs, money market tools, etc.), increasing income for liquidity providers and boosting DAO revenue—arguably one of the few advantages of “unified liquidity.”

Overall, the benefits of Aave V4’s unified liquidity for lending are not particularly significant, and the so-called composability—where borrowers can manage positions across different Spokes in a unified way—does not offer much more convenience than V3. But as I mentioned in the title, V4 transforms Aave from a product into a financial infrastructure similar to a “bank.”

Setting aside complex business operations, the core business of a bank is to accept deposits, keep a portion as reserves for daily payments and transfers, and earn interest rate spreads through lending. Idle funds can also be allocated to different investments within the bank’s risk appetite.

St. George’s Bank Headquarters at St. George’s Palace

Founded in Genoa, Italy, in 1407, St. George’s Bank is often considered the world’s earliest bank. It not only provided deposit and loan services but also handled government debt management, currency exchange, and fund transfers, meeting the commercial needs of Genoa as a major European trade hub at the time.

From launching ETHLend in 2017 to the launch of Aave V4 in 2026, less than ten years, Aave has essentially become a bank. Of course, the difference between Aave and a bank is significant; this is just an analogy. Compared to P2P, the bank model—having endured centuries of black swan events—is naturally a better choice, just as V4 is an evolution of V3.

If you observe carefully, many “innovations” in the DeFi space have almost become history’s dust, such as the DeFi 2.0 craze in late 2021. In contrast, simple projects like Aave, with logic matured over hundreds of years in traditional finance, have survived and thrived. After years of exploration, many DeFi projects have realized this: DeFi’s ceiling is high, but the path taken by traditional finance is indispensable.

Aave V4 consolidates liquidity, enabling many future possibilities, such as investing idle assets exceeding a certain period (e.g., one year) into higher-risk opportunities like providing ETH/USDT liquidity on Uniswap, operating entirely like a commercial bank, and gradually expanding into other banking services like credit cards (e.g., Ethfi’s model of collateralized stablecoin borrowing for spending).

Further, Aave could expand into an “investment bank” model—launching an ICO platform where users earning interest on deposited assets can lend USDT, USDC to participate in investments, without needing to withdraw and sell assets to buy stablecoins for ICO participation. This way, projects can be charged fees, and interest income can be generated simultaneously.

Although the Hub & Spoke mechanism doesn’t bring significant innovation to lending itself, it lays the most important groundwork for the next steps.