Aave Lending Business Model Explained

Aave's Proposed Institutional Lending Business

Aave Labs' September 30 clarification identifies an Aave Labs entity as the contractual lender and confirms that the DAO-funded route would pay prevailing Aave V3 stablecoin borrowing rates. The proposal would put crypto collateral on both sides of the financing chain, with institutions pledging Bitcoin or Ether for dollar loans, while the organization governing the Aave lending protocol would initially borrow those dollars against a separate pool of its own crypto assets.

The combined $50 million request is capacity for lending against BTC and ETH, with actual outstanding loans remaining undisclosed. Aave Labs reports approximately $300 million of indicated demand and describes a $20 million lead BTC facility.

Background and Timeline

Aave's proposed institutional lending business has been in the works for several months, with the September 24 proposal marking a significant milestone. The proposal outlines the terms and conditions of the lending business, including the use of crypto collateral and the role of the DAO in funding the loans.

The timeline for the proposal is as follows: community feedback, followed by a Snapshot vote if sentiment is favorable, and an AIP (Aave Improvement Proposal) after a positive Snapshot. Aave Labs has promised to provide regular reporting on outstanding balances, collateral composition, LTV distribution, margin events, losses, and funding positions.

Expert Perspective

Experts in the field of crypto lending have noted that Aave's proposal poses both risks and opportunities. On the one hand, the use of crypto collateral on both sides of the financing chain could provide a more efficient and secure way of lending. On the other hand, the proposal also poses significant risks, including the potential for correlated stress scenarios and the impact of floating funding costs on the loan spread.

Implications for Readers in India

The implications of Aave's proposed institutional lending business for readers in India are significant. As the crypto market continues to grow and evolve, Indian investors and institutions are increasingly looking for ways to participate in the market. Aave's proposal could provide a new opportunity for Indian investors to access crypto lending, but it also poses significant risks that need to be carefully considered.

What to Watch Next

As the proposal moves forward, there are several key things to watch. First, the outcome of the community feedback and Snapshot vote will be crucial in determining whether the proposal moves forward. Second, the terms and conditions of the lending business, including the use of crypto collateral and the role of the DAO, will need to be carefully evaluated. Finally, the impact of floating funding costs on the loan spread will need to be closely monitored.

Two Collateral Books, Two Repayment Obligations

The September 24 proposal would initially fund lending by pledging DAO-owned WETH and WBTC, with AAVE permitted up to 50% of collateral at each pledge. The DAO would borrow USDC or USDT on Aave V3 and use that financing for institutional facilities.

Separately, the institutional borrower would place BTC or ETH with a qualified custodian, with that collateral securing the borrower's loan under a Master Loan Agreement with an Aave Labs entity. A three-party Account Control Agreement would connect the lender, borrower, and custodian.

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• The DAO's onchain pledge would be separate from the borrower's custody account.
• Borrower collateral would never be rehypothecated, or pledged onward.
• The proposed custodian would monitor borrower collateral, issue margin calls, and liquidate if those calls were unmet.

Floating Funding Can Consume the Loan Spread

Aave Labs gives indicative borrower pricing of 6% to 8% APR against approximately 4.5% funding costs, implying a 1.5 to 3.5 percentage-point interest spread for the DAO. However, the September 30 reply makes clear that 4.5% is an indicative cost that can change.

An illustrative calculation shows the exposure, with a rise to 6% funding exhausting the interest spread even if the borrower paid in full. At 7%, the unchanged loan coupon would be below the cost of funds.

Disclosures Would Show How Much Pressure the DAO Can Absorb

The proposal's published path remains community feedback, followed by Snapshot if sentiment is favorable and an AIP after a positive Snapshot. Aave Labs promises reporting on outstanding balances, collateral composition, LTV distribution, margin events, losses, and funding positions.

Risks and Opportunities

Aave's proposed institutional lending business poses significant risks, including the potential for correlated stress scenarios and the impact of floating funding costs on the loan spread. However, it also provides opportunities for investors to access crypto lending and for the DAO to generate revenue.

Conclusion

In conclusion, Aave's proposed institutional lending business is a significant development in the crypto lending space. While it poses risks and opportunities, it also provides a new way for investors to access crypto lending and for the DAO to generate revenue. As the proposal moves forward, it will be important to closely monitor the outcome of the community feedback and Snapshot vote, as well as the terms and conditions of the lending business.