What’s Going On In Aave V3?

What’s New In Aave V3?

Aave V3 is now live across six different networks, including Avalanche and Polygon, each with its own list of supported assets and interest rates. While the Ethereum mainnet is not included in the initial release, it will be deployed based on the community’s decision. In the meantime, users can still access the Version 2 markets through the same interface simply by switching between the Aave markets.

Source: Aave.com

Version 3 of the Aave Protocol brings tons of new updates, including both significant upgrades and minor enhancements that seek to benefit everyone within the Aave ecosystem. While much of the core functionality remains the same, Aave V3 introduces new modes for lending while promoting higher capital efficiency and lower gas costs. Among these new features are cross-chain lending ‘portals’, a new High-Efficiency Mode, and Isolated Mode. Combined with numerous other technological improvements, there’s certainly a lot to unpack here, so let’s dive in!

Portals

Some crypto natives may be familiar with the portals associated with Aavegotchi, a DeFi and NFT protocol built on top of Aave. However, these portals are a different beast altogether. Essentially, portals are a new feature where liquidity can easily flow between Aave V3 markets on different chains using Aave’s aTokens. These fungible tokens typically function as a receipt for depositors, allowing holders to redeem them for the underlying assets. But now, they can be used to facilitate cross-chain movement of deposits without going through the full motion of withdrawing and bridging.

Source: Aave V3 Documentation

From a technical standpoint, the aTokens, be it aUSDC or aETH, will be burnt on the original network while new ones will be instantly minted on the destination network. By design, aTokens are usually backed by deposits on lending markets within the same chain, but since the newly minted ones are on a different chain, they are considered unbacked for now. At the same time, the user’s funds will be withdrawn from Aave and transferred to the user immediately.

Once these assets have been successfully transferred to the destination network, the underlying asset is then automatically resupplied into Aave’s lending pools, which now fully backs the previously minted aTokens. If we take a closer look, these functions are similar to withdrawing and bridging the funds yourself, but now simplified into one fluid transaction.

Using the portals from Aave V3, multichain bridges such as Connext Network, Hop Protocol, and Anyswap can access deep liquidity for various aTokens, increasing the potential for more complex cross-chain transactions. At this point in time, only approved bridges will be able to take advantage of this new feature, which will be dictated by Aave governance.

High-Efficiency Mode

Otherwise known as E-Mode, High-Efficiency Mode allows borrowers to make the most out of their collateral. Under normal circumstances, users are often limited by conservative loan-to-value (LTV) ratios, but this new function allows you to borrow up to 98% of your collateral value!

To put it simply, assets that are strongly correlated in price are now grouped together into specific categories. Generally, these assets are stablecoins pegged to a fiat currency, such as DAI or USDC which are pegged to the USD. Other categories include derivatives with the same underlying asset, such as stETH and alETH. 

When your deposits and borrowed assets are in the same category, you can opt to activate E-Mode, allowing you to unlock higher capital efficiency. Each category will have its own customized risk parameters, including higher LTV ratios and lower liquidation thresholds. Users can choose to switch between categories or disable the function as long as all their borrowed assets are within that same category. In the future, Aave V3 would be able to support up to 255 different E-Mode categories, to be determined by Aave governance. 

Source: Aave V3 Technical Paper

Using the illustration above, let’s assume that a user would like to borrow alETH, using ETH deposits as collateral. Typically, this would allow them to only borrow up to 82% of their total ETH on Aave. But if they choose to enable E-Mode for ETH, the category’s risk parameters, as defined by Aave governance, will override the existing ones set for selected assets within that category. In other words, the user would be able to borrow alETH up to 95% of their ETH collateral instead of only 82%, improving their borrowing power by up to 25%. 

With the introduction of V3, users would still be able to access the Aave Protocol as per usual, as High-Efficiency Mode will not be turned on by default. The feature can only be enabled manually, and you can only borrow specific assets within that category unless you choose to disable it. As of time of writing, E-Mode can only be enabled for stablecoins for now by submitting an on-chain transaction, which incurs gas costs. However, this already unlocks significant utility for users as each chain will have various stablecoins that you can access within that category.

 Source: Aave.com

Isolation Mode

While Aave generally supports blue-chip assets that have a proven track record and deep liquidity, it doesn't exactly provide the proper infrastructure for more exotic assets. Competitors like Rari’s Fuse Pools and Sushi’s Kashi lending pools allow users to earn yield or obtain leverage on much riskier assets that are otherwise unachievable through most centralized exchanges and decentralized exchanges. With Aave V3, the protocol is now jumping into this niche market through their new Isolation Mode.

Isolation Mode allows new assets to be listed on Aave in the form of ‘isolated assets’. Users may deposit these assets to earn yield from borrowers. However, borrowers who wish to use these isolated assets as collateral cannot use other assets as collateral, but they may still supply them to Aave’s lending pools to generate yield.

Source: Aave V3 Technical Paper

By providing isolated assets as collateral, users can only borrow stablecoins that have been pre-approved by Aave governance. Besides that, borrowers are restricted by a specific debt ceiling, meaning that they can only borrow stablecoins up to a fixed amount. These restrictions are in place so that Aave can accept deposits of long-tail cryptocurrencies while still managing their risk exposure to those particular assets.

For instance, let’s say that Aave governance has decided to list Token X as an isolated asset with a maximum debt ceiling of $5 million. If a user chooses to supply Token X as collateral, they can only borrow up to $5 million worth of stablecoins, either in USDC, USDT, or DAI. Also, other assets may not be used as collateral once Isolation Mode has been enabled. The user can opt to disable Isolation Mode by disabling Token X as their collateral once their debt has been paid or if the debt ceiling is removed.

Other Features

While we’ve covered the three major features in Aave V3, there are plenty of other updates and quality-of-life improvements that help upgrade the user experience for depositors, borrowers, and pretty much everyone else within the Aave community. Although this is not an exhaustive list, here are some of the more prominent ones, in no particular order.

Supply and Borrow Caps

Aave Governance can now configure deposit and borrowing limits for individual markets. Borrow caps help to control how much debt can be taken for a particular asset, while supply caps help to mitigate overexposure to any one asset while protecting against external risks such as infinite minting and price oracle manipulation. If the deposits have already exceeded the supply cap before it can be enforced, existing depositors will not be affected, but the pool will remain locked from further deposits.

Repayment with aTokens

Users can now opt to repay their existing debt positions with aTokens if the borrowed asset has been redeposited into Aave’s lending markets. This feature is especially useful for advanced users who are running farming strategies on Aave to earn leveraged returns. For example, suppose you deposit USDC to borrow DAI and choose to redeposit it into Aave. You can then repay the DAI debt using your received aDAI through a single transaction without having to withdraw or approve anything. Although your debt may not be repaid entirely if the borrowing interest is higher than the yield received from supplying assets, it becomes much simpler to derisk your position during more volatile periods.

Source: Aave.com

Risk Admins

The crypto space is always moving at light speed, and sometimes unexpected events can happen too quickly before anyone can react. As such, Aave governance can now approve certain entities such as DAOs or smart contracts as Risk Admins who can update an asset’s risk parameters without going through a voting process. Risk Admins can even expand on this feature by automating any necessary adjustments should a black swan event occur.

Claim on Multiple Rewards

In the previous iteration of the Aave Protocol, liquidity mining rewards were only in the form of stkAAVE or staked Aave governance tokens. Aave V3 will allow protocols and networks to provide their native tokens as additional incentives for users to supply liquidity. Suppliers will be able to receive multiple rewards for each asset, either to their account or to others, all within a single transaction.

Closing Thoughts

While many DeFi projects have slowly faded into obscurity, Aave has remained strong with constant innovation and a very active community. Aave V3 is a testament to how the lending protocol is always looking to improve and to become the most widely used dApp in the space.

As with all forms of experimental software, you should exercise extreme caution and do the necessary research before committing your funds. This really is the bleeding edge of crypto and DeFi, and though their smart contracts and code have been heavily battle-tested and audited by multiple firms, the introduction of more moving parts in V3 could open up new attack vectors for exploiters. If you do decide to participate in Aave V3, you should only put in what you are willing to lose in the event the worst might happen.

If you’re ready to try out the new features, head to Aave right now to check out their revamped user interface, and give Aave V3 a shot!