Aave, a leading DeFi protocol, is actively advancing the upgrade of its V4 version, which includes the construction of a “Unified Liquidity Layer” (ULL) to aggregate liquidity from multiple networks within a single protocol. The timeline for this upgrade indicates that Aave plans to begin the prototype design of the V4 protocol in the fourth quarter and aims to complete the code by the second quarter of 2025. However, Aave founder Stani Kulechov’s recent statement suggests that the launch of the Aave Network will come after the V4 version, possibly even earlier than expected.
The main upgrade in Aave V4 is the introduction of the “Unified Liquidity Layer,” which is essentially an extension of the Portal concept in Aave V3. The Portal was originally designed as a cross-chain bridging feature for different blockchains covered by Aave. However, most users are not familiar with or have not used this feature. Let’s delve into how the Portal has evolved into the “Unified Liquidity Layer.”
The Portal was initially intended to facilitate cross-chain bridging of supplied assets across different blockchains covered by Aave. This feature allows whitelisted bridging protocols to burn aTokens on the source chain and instantly mint aTokens on the target chain. For example, if Alice has 10 aETH on Ethereum and wants to move them to Arbitrum, she can submit a transaction to a whitelisted bridging protocol, which will then execute the following steps:
1. Mint 10 “underlying asset-backed” aETH on the target chain (Arbitrum), which actually represents the assets that have not yet been transferred to the target chain.
2. The bridging protocol transfers the 10 aETH to Alice on Arbitrum.
3. Multiple bridging transactions are batched and the 10 ETH, which serves as the underlying asset, is moved to Arbitrum.
4. Once the funds are available on Arbitrum, the whitelisted bridging contract on Arbitrum supplies the 10 ETH to the Aave pool to support the previously minted 10 aETH.
In the above example, Aave can move Alice’s 10 aETH from Ethereum to Arbitrum. In reality, this feature can handle various scenarios, such as general asset cross-chain transfers or allowing Alice to directly withdraw 10 ETH on the Arbitrum network.
The Portal feature enables users seeking higher interest rates across different blockchains to easily execute cross-chain operations. For instance, if there is a period where the pool on Optimism is relatively small but offers a higher deposit rate compared to the pool on Ethereum, users can use the Portal to migrate their deposits from Ethereum to Optimism and enjoy the higher deposit rate.
However, although the Portal allows Aave V3 to disregard liquidity barriers between chains, its operation relies on certain trust assumptions. In simple terms, users need to submit bridging transactions to some whitelisted bridging protocols (e.g., Connext) rather than the Aave V3 core protocol itself. It is important to emphasize that end users cannot currently use the Portal solely through the Aave core protocol.
This leads to the concept of the “Unified Liquidity Layer,” which is the most significant architectural change from Aave V3 to V4. The Unified Liquidity Layer adopts a modular design to manage “supply/borrow limits,” “interest rates,” “assets,” and “incentives” in a unified manner, allowing modules to extract liquidity from it.
By integrating liquidity management, the Unified Liquidity Layer enables Aave to more efficiently utilize all available assets. This means that liquidity can be dynamically allocated to where it is most needed, thereby improving overall capital efficiency.
Furthermore, the modular design allows Aave to add new modules or features (such as isolation pools, RWA modules, or CDPs) or introduce new modules or retire old ones without migrating liquidity while maintaining the normal operation of the entire system.
In Aave V3, the Portal allows assets to move between different networks covered by the Aave protocol, activating cross-chain liquidity. The Unified Liquidity Layer creates a more flexible and abstract infrastructure that encompasses this functionality and can support a wider range of liquidity supply needs.
Under the framework of the Unified Liquidity Layer, Aave will leverage Chainlink’s Cross-Chain Interoperability Protocol (CCIP) to build a “Cross-Chain Liquidity Layer” (CCLL), allowing borrowers to instantly access all liquidity across all networks supported by Aave. This improvement is expected to develop the Portal into a full-fledged cross-chain liquidity protocol, and I am excited to see how Aave V4 utilizes this new infrastructure to discover new potential revenue sources.
In addition to the “Unified Liquidity Layer,” Aave is expected to introduce dynamic interest rate mechanisms, liquidity premium mechanisms, smart accounts, dynamic risk parameter configuration, and non-EVM ecosystem expansion in the V4 upgrade. The Aave Network will be built around stablecoin GHO and the Aave lending protocol itself, serving as a core hub.
As a well-established DeFi leader, Aave has held approximately 50% of the DeFi lending market share for the past three years. If we include forked projects, about 75% of the value in the DeFi lending market is locked in projects that utilize Aave’s codebase version.
For the V4 version, Aave has high expectations: “These improvements are aimed at significantly driving further adoption of the Aave ecosystem and helping DeFi expand further to serve potential new users in the billions.”
