Aave has long been on my radar, and just a few days ago, its governance team, ACI, unveiled a draft of Aave’s upgraded tokenomics on the governance forum. This proposal details expected enhancements in key areas, including the token value capture of Aave and improvements to the protocol’s safety modules.
For more insights on Aave, read my recent research Altcoins Keep Falling, Time to Refocus on DeFi, where I thoroughly evaluate its current status, competitive edges, and token valuation.
This article delves into the significantly impactful new proposal, specifically answering the following four key questions:
- What are the main points of the proposal?
- The potential impacts associated with these points.
- The scheduled timeline and prerequisites for the proposal’s activation.
- The potential long-term effects of this proposal on the valuation of $AAVE token.
You can read the proposal here.
Contents
The Main Points of the AAVEnomics Proposal
The proposal, titled “[TEMP CHECK] AAVEnomics Update”, is currently in the preliminary “temperature check” phase of community proposals and was posted on July 25th. The initiator of the proposal is ACI, which can be interpreted as the governance arm of the official Aave team and the central coordinator for community governance. ACI’s major proposals are usually fully communicated with other governance representatives and professional service providers before release, resulting in a high likelihood of approval.
The main points of the [TEMP CHECK] AAVEnomics Update include:
Overview of Aave’s Robust Operational Health and Strong Financial Reserves
Aave continues to lead the DeFi lending space, with revenues substantially outstripping expenses. With reserves mostly in $ETH and stablecoins, there is a timely opportunity to update the tokenomics and begin the distribution of protocol revenues.
Bad Debt Management Update: Transition From the Old Safety Module to The New “Umbrella” System
Aave has established reserves known as the “Safety Module” to address potential bad debts within the protocol. These reserves consist of:
- Staked $AAVE, with a current market value of $275 million
- Staked GHO, which is a native stablecoin of Aave, holds a current market value of $60 million
- Staked $AAVE-$ETH LP tokens, a significant source of on-chain liquidity for Aave, currently valued at $124 million
The proposed Umbrella safety system is set to replace the traditional safety module. Specifically:
- The bad debt reserves within the system will be administered by the innovative aToken module, which is funded by user-initiated voluntary deposits. Depositors not only continue to accrue their usual interest but will also receive an additional security subsidy, which will come from Aave’s protocol revenue.
The Evolving Role of Aave Tokens and Initiation of Protocol Revenue Distribution
The Aave staking module remains operational, yet its role has evolved beyond serving as a risk reserve. It now fulfills two vital functions:
- Stakers are eligible to receive distributions from the protocol’s profit surplus, beyond what is necessary for operations. This distribution is managed by Aave treasury, which executes periodic buybacks of $AAVE on the secondary market based on community governance proposals, benefiting the stakers.
- Staked $AAVE yields “Anti-GHO,” which can be used either to repay GHO debts or directly deposited into the GHO staking module, thereby enabling $AAVE stakers to also benefit from the profits generated through GHO.
Modifications to the GHO Staking Module
Initially, the GHO staking module was responsible for bad debts across the entire Aave protocol. However, following recent changes, its coverage is now specifically limited to bad debts associated with GHO liabilities alone.
Other Updates
- The liquidity of $AAVE is no longer dependent on the Aave – ETH staking incentives but is now operated by the ALC (Aave Liquidity Committee).
- The swap from the initial protocol token, $LEND, to $AAVE will be discontinued, with any tokens not exchanged by the deadline being allocated to the treasury.
The following graph visibly depicts Aave’s new tokenomics:
Effects of the Proposal
There are two primary effects:
- Aave tokens now exhibit a more defined capture of value, with a corresponding reduction in sell pressure, which further aligns with the protocol’s robust development.
- The value capture originates from buybacks funded by protocol net revenues plus GHO interest profit.
- The decrease in sell pressure is due to the phasing out of the staking module, implying that Aave will utilize stablecoins and ETH from protocol revenues for expenditures, instead of issuing new $AAVE tokens. This shift will reduce Aave’s market pressure and enhance its scarcity.
- The introduction of the Umbrella system will enhance the flexibility of the protocol structure and optimize incentive distribution, elevating the ceiling for safety governance and raising higher governance requirements.
- Previously, the Aave safety module is fully incentivized by $AAVE token emissions, which offered limited flexibility. In contrast, the Umbrella safety module, similar to Eigenlayer’s AVS model, is a modular system that allows for customized incentives based on asset type, duration, and capacity.
- Moreover, this change means that Aave’s risk team must now consider an additional set of metrics when evaluating and establishing risk parameters, beyond market size, interest rate curves, and loan-to-value ratios.
Timeline and Prerequisites for Implementation
ACI said that the rollout of the plan will occur in a phased approach, contingent upon specific prerequisites. It will be structured into three stages, each corresponding to a separate governance proposal, to execute the outlined measures.
Phase I: Staking Module and GHO Update
- Staked GHO(StkGHO) will solely cover the bad debt associated with GHO liabilities.
- The Aave and AAVE-ETH staking modules will be transitioned to “Legacy Safety Modules,” maintaining their guarantee roles until they are phased out. The cooldown period for withdrawing staked $AAVE has been eliminated.
Prerequisites: Met
Timing of Implementation: The proposal is set to move forward once it receives sufficient community input and BGD Labs, Aave’s primary community developer, has approved the Umbrella upgrade.
Phase II: $AAVE Token Utility Upgrade and Introduction of New Tokenomics
- The functionality that allowed for GHO borrow rate discount through AAVE staking will be discontinued.
- The Anti-GHO feature will be introduced, enabling AAVE stakers to obtain Anti-GHO.
- The swap from Lend to Aave tokens will be ended.
Prerequisites:
- The market size of GHO must reach $175 million, up from the current level of approximately $100 million.
- GHO’s market liquidity needs to support a $10 million trading depth affecting the price by less than 1%. Currently, a trading of about $2.1 million is sufficient to move the GHO price by 1%.
Phase III: Activation of Fee Switch and Initiation of Buybacks
- Turn off the legacy security module.
- Activate the aToken mode of the Umbrella Security Module, enabling users to back the system with their deposits and earn extra rewards.
- Aave’s financial service provider manages the governance-driven buyback of $AAVE tokens and distributes them to Aave stakers, progressively transitioning to an automated process.
Prerequisites:
- The average net asset value in Aave’s revenue pool over the last 30 days must be adequate to cover the operational costs of current service providers for the next two years.
* As of now, Aave’s treasury, excluding AAVE tokens, holds assets valued at approximately $67 million, with 61% in stablecoins, 25% in Ethereum, and 3% in Bitcoin. The forecasted expenses for 2024 are about $35 million, according to the head of ACI. Assuming similar expenses for 2025, the combined expenses for the two years would be around $70 million. Given Aave’s consistent weekly revenue of $1-2 million in 2024, the threshold is nearly met, and it is projected that this level could be achieved within a month.
- The annualized revenue from the Aave protocol for the past 90 days must account for at least 150% of the total protocol expenses in 2024, which includes the allocations for $AAVE token buybacks and the funding for the Umbrella safety module.
*Budgets are defined, allocated, and adjusted quarterly by the Aave Finance service provider.
Overall, Phase I is ready for deployment. Phase II could take a few more months, contingent upon the Liquidity Committee’s dedication to and budget for GHO liquidity. The rollout of Phase III is more challenging to forecast due to its dependence on specific budgetary allocations, market dynamics, and revenue streams. Nonetheless, given Aave’s robust revenue performance, meeting the necessary criteria is likely manageable.
Long-Term Impact of the Proposal on $AAVE Token Prices
Over the long term, this proposal establishes a direct connection between the progression of the Aave protocol and the $AAVE token for the first time. It introduces a buyback support mechanism that underpins the token’s floor price while providing token holders with a stream of profit. This strategy is expected to positively influence the token price.
However, given that the implementation of the proposal requires time and will be executed in phases, combined with the fact that the proposal was only released recently and there is still a need for discussion and revision on specific terms, the value capture of the $AAVE tokens will be a gradual and long term process.
However, should the proposal be successfully executed, Aave, one of the leading DeFi projects, may further captivate the interest of value-oriented investors due to its robust, transparent governance and rewarding approach towards token holders. Such interest is likely to extend beyond the crypto community, attracting newcomers to Web3 from the traditional financial sectors.
