Aave avoided bad debt by shifting risk to borrowers: Bank of Canada study

A Bank of Canada unit insubstantial recovered that Aave V3 reported zero non-performing loans successful 2024, with overcollateralization and automated liquidations helping forestall lender losses successful its Ethereum lending market.

Using transaction-level information from Jan. 27, 2023, to May 6, 2025, the study recovered that positions were typically liquidated earlier collateral values fell beneath outstanding debt, helping incorporate lender losses crossed the sample.

But the exemplary came with a tradeoff, the insubstantial said. While it protected lenders from unrecovered losses, it besides shifted hazard onto borrowers and constrained superior ratio compared with accepted lending systems.

According to the paper, Aave V3’s plan relies connected automated hazard controls alternatively than accepted underwriting, requiring borrowers to station much collateral than they get and liquidating positions erstwhile they breach hazard thresholds.

Daily lending earnings, circulating supply, and borrowing volumes (USD) connected Aave V3. Source: Bank of Canada

Recursive leverage fueled borrowing demand

According to the paper, Aave V3’s lending enactment was not driven solely by users seeking liquidity. It recovered that recursive leverage accounted for implicit 20% of full borrowed measurement and 8.2% of borrowing transactions during the illustration period. 

Recursive leverage involves repeatedly borrowing against collateral, redeploying the borrowed assets arsenic caller collateral and borrowing again to amplify exposure.

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The survey said the dynamic made borrowers much exposed erstwhile markets turned. According to the paper, liquidations connected Aave V3 tended to hap successful concentrated waves, with 4 assets accounting for 90% of full liquidated value. 

This includes Wrapped Ether (WETH), Wrapped Staked Ether (wstETH), Wrapped Bitcoin (WBTC) and Wrapped eETH (weETH).

The insubstantial estimated that borrower losses during major liquidation events could beryllium significant. It said liquidation fees typically ranged from 5% to 10% of liquidated value, portion missed gains from consequent terms recoveries pushed combined losses to astir 10% to 30% successful immoderate cases. 

The unit insubstantial suggested that portion the plan for Aave V3 helped forestall unrecovered atrocious indebtedness successful the sample, it did truthful by exposing borrowers to abrupt losses erstwhile collateral prices fell sharply. 

Cointelegraph reached retired to Aave for remark but did not person a effect earlier publication.

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