Aave is a decentralized money market protocol that facilitates depositing and borrowing of various crypto assets. The protocol has two main versions; Aave V2 and V3, and is deployed across various Layer-1 chains and Layer-2 networks with the majority of activity on Ethereum, Avalanche, and Polygon. Outside of the core lending business, the protocol has introduced various complementary products: a stablecoin (GHO), an open social protocol (Lens Protocol), and a permissioned instance of the core Aave protocol (Aave Arc).
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Like many protocols, Aave's Q2 2022 was defined by two severe market drawdowns. First, the UST collapse in May triggered the beginning of a large leverage unwind. Subsequently, bad debt from crypto hedge fund, Three Arrows Capital, sparked a centralized lender collapse in June led by Celsius, one of Aave's largest users. Borrowers’ leverage demand contracted as prices sharply fell, leading to Aave’s total revenue decline of 18% in the quarter. The reinstatement of the Aave Grants Program in May drove expenses and helped push net income down 30% in the quarter to $2.7 million. While Aave’s overall revenue declined in the quarter, the decline was not proportionately shared across its various cross-chain deployments.
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The main Ethereum V2 deployment was the major source of the revenue decline as these markets were hit hardest by the Celsius collapse. Nearly 20% of all the outstanding debt on Aave Ethereum was repaid by Celsius’s main trading wallet from June 9 to July 13. These significant debt repayments in conjunction with over 50% broader price declines drove Aave’s Ethereum quarterly revenue down nearly 36% to $30 million.
Conversely, Aave’s Avalanche deployments actually grew revenue by 20% in the quarter. In fact, Aave’s total revenue on Avalanche outpaced Ethereum-based revenues for the last two months of the quarter. While this marked the first time another chain’s revenue outpaced Aave’s Ethereum deployments, it shouldn’t be expected to continue.
A large amount of the activity behind Aave’s total revenue on Avalanche is currently subsidized by the Avalanche Rush incentives in the form of native AVAX tokens. For example, the Aave Avalanche USDT markets are currently at an abnormally high 90% utilization rate for a bear market, due to the incentives. The incentives offset the borrowing rate below the rate paid to depositors, allowing borrowers to earn nearly risk-free yield by repeatedly redepositing borrowed funds. Incentives to this degree don’t add true value and are unsustainable. However, since the Rush rewards are issued by Ava Labs, the incentives come at no tangible cost to Aave and have helped keep quarterly revenues moderately healthy in a down market.
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Over the previous four quarters, stablecoin loans have contributed as much as 98% of Aave’s revenue on a quarterly basis. While still significant, the Q2 2022 revenue contribution from stables dropped to a six-quarter low of 82%. The decline in stablecoin revenue share was largely due to two factors: the repayment of DAI, and the surge in demand to borrow ETH and BTC. Since DAI is issued as debt, its market cap dropped by a third as debtors unwound many of their positions following May’s Terra implosion. The jump in ETH and BTC interest revenues came as users sought to profit from the broader market declines by borrowing and selling these assets (i.e. shorting these assets).