Is Aave's Valuation Severely Underestimated? A Deep Analysis of Its Position as a Core Pillar of Decentralized Finance and On-Chain Economy

The on-chain lending market is an important component of the crypto industry, and Aave, as a leader in this field, has strong competitive advantages and user stickiness. We believe that Aave's value is severely underestimated by the market, and its growth potential has not been fully recognized.

Aave launched on the Ethereum mainnet in January 2020 and has now entered its fifth year. Currently, Aave is the largest lending protocol by scale, with a total active loan amount of up to $7.5 billion, which is more than five times that of the second-ranked Spark.

Protocol metrics continue to grow, surpassing the previous bull market peak

Aave is one of the few DeFi protocols whose metrics have surpassed the levels of the 2021 bull market. For example, its quarterly revenue has exceeded the bull market peak of the fourth quarter of 2021. Notably, even during the market adjustment period from November 2022 to October 2023, Aave's revenue has continued to accelerate. With the market warming up in the first and second quarters of 2024, Aave's growth momentum remains strong, with a month-on-month growth rate of 50-60%.

Since the beginning of the year, thanks to the increase in deposits and the rise in prices of underlying assets such as WBTC and ETH, Aave's total locked value (TVL) has nearly doubled, recovering to 51% of the peak value of the 2021 cycle. This indicates that Aave has shown stronger resilience compared to other leading DeFi protocols.

Strong profit performance reflects the high alignment of products with the market.

Aave's revenue peaked in the last cycle, coinciding with multiple smart contract platforms attracting users and liquidity through the large issuance of token incentives. This brought unsustainable speculative capital and leverage levels, amplifying the revenue data of most protocols.

Currently, the token incentives of major public chains have been exhausted, and Aave's own token incentives have also dropped to negligible levels. This indicates that the metric growth in recent months is organic and sustainable, primarily driven by the recovery of market speculation activities, which in turn has increased active lending and borrowing rates.

Moreover, even during periods of reduced speculative activity, Aave has demonstrated the ability to drive fundamental growth. In early August, when the global risk asset market experienced a significant decline, Aave's revenue remained strong, thanks to its successful collection of liquidation fees during the loan repayment process. This proves that Aave possesses the capability to withstand market fluctuations across different collateral and multi-chain environments.

Although the fundamentals are recovering strongly, Aave's price-to-sales ratio is still at its lowest level in three years.

Despite a strong recovery in indicators over the past few months, Aave's price-to-sales ratio is only 17 times, at its lowest level in 3 years, significantly lower than the median level of 62 times during the same period.

Aave is expected to strengthen its leadership in the Decentralized Finance lending space.

Aave's competitive advantages are mainly reflected in four aspects:

1. Protocol security management records are good: So far, Aave has not experienced any major smart contract level security incidents. A good security record is often a primary consideration for DeFi users when choosing a lending platform, especially for large users managing substantial funds.

2. Bilateral network effects: DeFi lending is a typical two-sided market. Depositors and borrowers form the supply and demand sides, and growth on one side drives growth on the other, making it increasingly difficult for newcomers to catch up. In addition, the more abundant the platform's overall liquidity, the smoother the deposit and withdrawal processes, which enhances its appeal to large fund users and further stimulates the platform's business growth.

3. Effective DAO Management: The Aave protocol has fully implemented a DAO-based management model. Compared to centralized team management, DAO involves more comprehensive information disclosure and deeper community discussions. Aave's DAO community brings together a group of highly skilled governance professional institutions, including top risk management service providers, market makers, third-party development teams, and financial advisory teams. This diversified participant structure leads to active governance participation for the platform.

4. Multi-chain ecosystem positioning: Aave has been deployed on almost all mainstream EVM-compatible Layer 1 and Layer 2 networks, maintaining a leading TVL position on all deployed chains except for BNB Chain. The upcoming Aave V4 version will enable cross-chain liquidity, further highlighting its cross-chain liquidity advantages.

Reform token economics, promote value accumulation, eliminate reduction risks

The Aave community recently proposed a reform to the AAVE token economics, aimed at introducing a revenue sharing mechanism to enhance the token's utility.

The first major change is to eliminate the risk of AAVE being reduced when calling the security module. The new Umbrella security module will replace stkAAVE and stkABPT with aUSDC and awETH. aUSDC and awETH suppliers can choose to stake their assets to earn additional fees (including AAVE, GHO, and protocol revenue) beyond the interest paid by borrowers. These staked assets face the risk of reduction and destruction in shortage events.

In addition, the yield distribution mechanism will further enhance the demand for AAVE. The introduction of the "anti-GHO" token allows users to choose to burn anti-GHO to mint GHO or deposit it into the GHO safety module to obtain stkGHO. This strengthens the alignment of interests between AAVE stakers and GHO borrowers.

Aave will also allow the net excess protocol revenue to be redistributed to token stakers, provided that specific conditions are met. This will initiate a continuous eight-digit buyback program, with the buyback scale increasing as the protocol continues to grow.

It is worth noting that AAVE's circulation is almost at a fully diluted state, and there will not be a large-scale supply unlock in the future.

Aave is expected to achieve significant growth

Aave has multiple growth drivers going forward and is expected to benefit from the long-term growth trend of cryptocurrencies as an asset class. From a fundamental perspective, Aave has several revenue growth avenues:

Aave v4

Aave V4 will further enhance its competitiveness, committed to revolutionizing the DeFi interaction experience by building a unified liquidity layer. It will simplify the cross-chain lending process, deeply integrate account abstraction and smart accounts, while expanding to more chains and introducing more asset classes.

Aave also plans to explore the integration of RWA-based products, which will be built around GHO, with the hope of connecting traditional finance with Decentralized Finance, attracting institutional investors and injecting a large amount of new capital into the Aave ecosystem.

These developments will ultimately give rise to the Aave Network, which will serve as the central hub for stakeholders to interact with the Aave protocol. GHO will be used to pay fees, and AAVE will serve as the primary staking asset for decentralized validators.

is positively correlated with the growth of BTC and ETH

The launch of Bitcoin and Ethereum ETFs this year is an important milestone in the popularization of cryptocurrencies. These ETFs are expected to attract significant capital from both institutions and retail investors, further integrating digital assets into mainstream portfolios.

For Aave, the overall growth of the crypto market is a positive factor, as over 75% of its asset composition consists of non-stable assets (primarily Bitcoin and Ethereum derivative assets). Therefore, Aave's TVL and revenue growth are directly related to the growth of these assets.

is linked to the growth of stablecoin supply

In the future, Aave is expected to benefit from the growth of the stablecoin market. As central banks around the world may enter a rate-cutting cycle, the opportunity cost for investors seeking sources of yield will decrease. This could incentivize capital to flow from traditional financial yield instruments into stablecoin farming in the DeFi space for higher returns. Furthermore, during bullish market conditions, investors' risk appetite increases, and risk-seeking behavior becomes more common, which will further stimulate stablecoin lending activities on platforms like Aave.

Conclusion

We are optimistic about the prospects of Aave as a leading player in the decentralized lending space that continues to grow. With strong network effects, excellent token liquidity, and composability, Aave is expected to further solidify and expand its market dominance. The upcoming tokenomics upgrade will further enhance the protocol's security and strengthen its value capture capabilities.

In recent years, the market tends to categorize all DeFi protocols into one class and price them as an asset class with limited growth potential. This phenomenon can be seen in the steady increase of Aave's TVL and revenue while the valuation multiples are declining against the trend. We believe that this mismatch between valuation and fundamentals will not persist in the long term. AAVE currently offers highly attractive risk-adjusted investment opportunities in the crypto industry.