Interpreting Aave's new economic model: Dividend buyback, security module upgrade

Author: Alex Xu, Mint Ventures

Aave is one of the projects I have been following for a long time. Yesterday, the governance team ACI of Aave released a draft of the new economic model on the community forum, announcing expected upgrades in terms of value capture of Aave tokens, security mode of the protocol, and other aspects. In this article, I will mainly address the following 4 questions regarding this influential proposal:

1. What are the main contents included in this proposal?

2. The potential impact of each major content

3. The timetable and trigger conditions for the implementation of the proposal

4. How might this proposal affect the price of the Aave token in the medium to long term?

Original proposal:

I. Core Content of the AAVEnomics Proposal

The proposal, titled [TEMP CHECK] AAVEnomics update, is in the early stage of community proposal, namely the “temperature check” stage, and was posted 15 hours ago. The proposer is ACI, which can be understood as the governance representative of the Aave official team. ACI is also the brain and main coordinator of community governance. Its important proposals are generally communicated extensively with other governance representatives and professional service providers before they are released, so the probability of passing is very high.

[TEMP CHECK] The main content of AAVEnomics update is as follows:

1. Introduces Aave’s current good operating status and ample financial reserves

The project is in a sustained leading position in the lending field, with income far exceeding project expenses, and reserves long for ETH and stablecoins, thus providing an opportunity to update the economic model and initiate protocol income distribution.

2. Bad Debt Processing Mechanism Update: The original ‘Security Module’ is gradually exiting the stage, and the new security system Umbrella is online.

• Aave currently provides reserves for potential protocol defaults, a mechanism called “Safety Module”, which currently consists of three parts:

• Aave stake, now valued at 2.75 billion US dollars
  • The Aave native Stable Coin GHO for staking is now worth $60 million
  • Aave-ETH LP staked, also one of the main sources of Liquidity on the Aave chain, currently valued at $124 million

• The new “Umbrella” security system will replace the original security module, specifically:
  • The bad debt reserve of the system will be managed by the new aToken module, which is funded by users who voluntarily deposit their funds. After depositing, users will not only receive the original deposit Interest income, but also receive additional security subsidies, which are derived from Aave’s protocol revenue.

3. The new role of Aave Token, and the start of protocol profit distribution

• The Aavestake module still exists, but Aave no longer serves as a risk reserve for staking, but has two functions:

• You can obtain the profit surplus of the protocol beyond the funds needed for operation, by the Aave financial team regularly repurchasing Aave in the Secondary Market and distributing it to the depositors through community governance proposals.
  • By staking Aave, you can obtain “Anti-GHO”, which can be used to offset your GHOStable Coin debt, or directly deposited into the GHOstake module, allowing Aave to also generate profits from GHO.

4. Changes in the GHO stake module

The original GHOstake module required guaranteeing the entire Aaveprotocol system’s bad debt, but the updated version only guarantees the bad debt of the GHO portion.

5. Others

• The Liquidity of Aave token no longer relies on the stake module’s Aave - ETH incentives, but is entrusted to the ALC (Aave Liquidity Committee) The initial Token Lend of the protocol will cease to be exchanged for Aave, and Tokens that are not exchanged on time will be allocated to the national treasury.

Aave’s new economic model relationship diagram can be seen:

2. The impact of this proposal

The main impacts are twofold:

• AaveToken has a relatively clear value capture, and the further drop in selling pressure is further linked to the good development of the protocol
  • Value capture comes from: protocolInterest Spread part of the income buyback + GHOInterest income feedback The reduction in selling pressure comes from the deactivation of the stake module, which also means that Aave will use stablecoin and ETH income from the protocol as expenditure tokens instead of Aave tokens, directly reducing selling pressure on Aave and making Aave more scarce.
• The introduction of the Umbrella Security Module makes the structure of the protocol more flexible, further optimizing the incentive of the protocol, further enhancing the upper limit of the protocol’s security governance, and proposing higher governance requirements.

• The original Aave Safety Module relied solely on Aave emissions for incentives, with limited flexibility. The Umbrella Safety Module is similar to Eigenlayer’s AVS model, which is a modular module that allows for custom incentives based on asset type, time, and capacity.
  • This also means that Aave’s risk team has added another indicator that needs to be evaluated and formulated, in addition to asset size, Intrerest Rate curve, LTV and other risk indicators.

三. The timetable and prerequisites for the landing of the solution

ACI indicates that the implementation of the plan will proceed gradually and be divided into three phases (three governance proposals) based on different prerequisites to implement the above content.

Phase One: stake mechanism and GHO mechanism modifications

• GHOstake is only responsible for the bad debt guarantee of the GHO debt part
• The Aave and Aave - ETHstake modules have been changed to ‘Legacy Security Modules’ and continue to function as collateral before being replaced. The cooldown period for Aavestake is set to 0.

Prerequisite: Has been achieved

Execution time: This proposal has obtained sufficient community feedback, and BGD Labs, the main community developer of Aave, has approved the Umbrella upgrade.

Phase 2: Aave Token functionality update, new economic model gradually launched

• End stakeAave to get GHOInterest discount function
• The Anti-GHO function is online, staking AAVE can obtain Anti-GHO
• Close Lend exchange Aave

Prerequisites:

• GHO scale reaches 175 million (currently around 100 million)
• GHO’s secondary Liquidity can achieve “10 million trading volume with price impact less than 1%”, and the current trading volume that affects GHO’s price by 1% is around 2.1 million.

Phase 3: Aave fee switch activated, triggering buyback

• Close the traditional security module
• By activating the aToken mode of the Umbrella Security Module, users can use their own deposits as collateral for the system and receive additional rewards.
• Aave financial service providers initiate Aave’s buyback and allocate it to Aave stakers through governance, gradually achieving automation

Prerequisites:

• The average asset net worth of Aave’s income pool in the past 30 days is sufficient to cover the expenses of existing service providers for 2 years

**Currently, the total assets excluding the Aave token in the Aave treasury are approximately $67 million (61% stablecoins, 25% Ethereum, 3% BTC), while Aave’s annual expenditure in 2024 is approximately $35 million (data provided by the ACI leader). If the expenditure level in 2025 is similar, the expenditure for two years would be $70 million. Considering that Aave’s weekly income since this year has been basically between $1-2 million, the two are already quite close and can reach this level in about a month.

• Aaveprotocol’s annualized revenue in the past 90 days has reached 150% of all protocol expenditures since the beginning of the year, including AAVE’s buyback budget and umbrella security module expenditures.

*The budget is defined, funded, and adjusted by Aave Finance service providers on a quarterly basis.

Overall, Phase One is ready for launch, and Phase Two is expected to take several months (depending on the Liquidity Committee’s budget and investment in GHO liquidity). It’s difficult to predict the timing of Phase Three’s launch, as it’s influenced by factors such as specific budget plans, market conditions, and revenue. However, considering Aave’s strong revenue level at present, meeting the criteria shouldn’t be too difficult.

Four. How will this proposal affect the long-term price of Aave Token

In the long run, the proposal for the first time explicitly links the development of Aave protocol with Aave Token, providing a buyback support for the lower limit of Aave Token and generating cash flow income for holders, which is Favourable Information for Aave’s price.

However, considering that the implementation of the proposal takes time and is carried out in batches, coupled with the fact that the proposal was just released less than a day ago, specific terms still need to be discussed and modified, so the value capture of Aave tokens is a gradual and long-term process.

However, if the proposal is successfully implemented, Aave, as one of the largest Defi projects, its standardized and transparent governance, and the rewards for Token supporters, may further gain the favor of value investors, including not only those from the crypto world, but also newcomers from the TradFi sector of Web3.