Aave is one of the ecosystem's primary DeFi layers. Their primary offering is a neobank, in which users deposit monies that others can borrow. Aave's strategy, on the other hand, is aimed towards a much wider goal: the creation of the Aave super-app. Aave has expanded to seven different chains, launched an AMM token market, and a social network, and even integrated cross-chain signaling onto its backend.

Token holders control Aave through governance, as they do other crypto ventures. Token holders determine how Aave spends its cash, onboard new teams, the parameters for its products, and the entity's mission. This article begins with revenue and expenses.

How is Aave performing in comparison to itself, if we consider it a business? Are token holders properly managing the DAO's funds? Is spending matching revenue? Is Aave's revenue compared to the rest of the market? What effect will the neighboring macroenvironment have on Aave?

We look at Aave's basics to try to answer these problems.

Aave is an outlier in the cryptocurrency world since it provides adequate financial documentation. Beyond cross-referencing the chain and governance, looking at the basics of some DAOs would be extremely difficult.

Aave token holders receive monthly financial reports and webpages that disclose their expenditures and earnings – a standard that we hope becomes much more prevalent in this business.

Aave's paradigm

Aave's principal business plan as a neobank is straightforward: they charge customers to use their platform. When users borrow, deposit, liquidate, or take out a flash loan, they must pay fees. Fees are shared between the Aave DAO and those that stake AAVE tokens to backstop the protocol's risk in the Safety Module.

Through governance, AAVE holders can change the fee parameters for each asset. The precise charge amount determined for any asset is influenced by its supply, market capitalization, market depth, and other market-specific criteria. This means that any asset on Aave has a fee level that corresponds to the community's perception of its risk.

Determining these many protocol parameters between AAVE core contributors and AAVE holders is a difficult balancing act. Fees must be high enough to produce revenue for the protocol and offset any risks it takes, yet low enough to encourage platform adoption.

Revenue is the most important statistic for Aave's future development. Despite being a decentralized corporation, Aave must pay contributors and engineers to function on the network. Revenue is also crucial because Aave utilizes it to compensate Safety Module stakeholders. There is a minimal incentive for AAVE holders to backstop risk in the protocol if there is no meaningful revenue. Stakeholder and developer compensation is a key source of expense.

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Financial Analysis and Growth Prospects

Unfortunately for Aave, revenue fell throughout 2022 due to interest rate compression, a lack of borrowing demand, and more appealing return options in other markets. The amount of money Aave makes after paying stakeholders in the Safety Module is referred to as revenue. These are the monies that AAVE holders have access to. From January to November 2022, protocol revenue is expected to be around $21.75 million. This puts Aave on track for annual revenue of $23 million. Given that Aave has about $6.4 billion in TVL and a market cap of $1.19 billion, $23 million per year does not appear to be particularly profitable. Aave, on the other hand, draws deposits with a low net-interest margin, which means that Aave takes less money off the top for profits than typical banks, thus earnings may always be slightly subdued.

With $23 million in revenue, Aave has an estimated revenue per token of $1.62 (using circulating supply), but the current token price is $83.21. This income per token provides Aave with an eye-popping P/S ratio of 51.5, implying that AAVE tokens trade at a 51.5x multiple. A P/S of 40 is usual for a growth stock, thus 51.5 is generally reasonable for a DeFi protocol with potential for growth, such as Aave. A 51.5x multiple could even be considered modest for something like a DeFi token with a speculative upside.

When looking at Aave's revenue, there is an important nuance to consider. Some of Aave's fees are used to reward users who invest AAVE in the Safety Module. As a result, the total fees for the protocol are substantially larger, yet a major amount goes to stakers and is not available to the DAO.

When total fees are considered, the protocol has a P/S ratio of roughly 17.25. However, as we examine the DAO's foundations, we believe that focusing on the revenue generated by the DAO provides a much clearer picture. You would want to be mindful if a company paid out a substantial portion of its revenue as dividends to the point where it was operating at a deficit.

User Growth

Despite macro hurdles and a bad year for crypto in general, Aave's revenue prospects appear to be favorable, with reasonable user growth until 2022. New users increased throughout 2022, as evidenced by new wallets connecting with Aave. In 2022, about 140k new wallets connected to Aave. These are far from the only new users. Some new wallets are clearly connections between old users and new wallets. Regardless, this is a good sign for Aave. New addresses bring in new deposits, loans, and revenue to the protocol.

Even before 2022, we can see that daily active users on Aave remained quite stable into 2022. Aave currently depends on the larger market to improve so that it can capitalize and boost income.

aave daily active-users

Source: Token terminal

Aave's Primary Expenditures

Revenue is simply one component of the equation when looking at a company's fundamentals, as astute investors understand. Due to the importance of DeFi expenses for the future of a protocol, crypto investors must frequently pay closer attention to them. Aave's finances are looking bleak when it comes to expenses. According to the financial records provided by the Llama team, Aave lost $83M from January to November 2022. The Llama team has not yet provided the December report, so we may estimate a total loss for the protocol of roughly $85M.

Llama records expenses in a variety of ways, including liquidity incentives, staking rewards, and third-party payments. Each line item was greater than Aave's total revenue for the year. Aave spent $28.7 million on liquidity incentives and $37.3 million on staking rewards between January and November. These things, while essential, are similar to depreciation in a corporation in that they influence the overall condition of the company but do not lower cash on hand.

In the case of Aave, these line items are derived from AAVE token emissions, which reduce the protocol's potential to fund future activities through token sales. They also dilute existing token holders, however many systems use this method to pay for liquidity and incentives.

The most intriguing feature from the standpoint of business management is Aave's third-party expenses. Aave, as a decentralized entity, does not have a single entity that handles all development. Instead, businesses can apply for Aave money to fulfill certain activities. Typically, cash is provided to these companies as they work, but Aave also experimented with retroactive funding to construct its v3.

Aave's third-party partnerships cost the DAO around $40 million between January and November of 2022. September 2022 accounted for nearly all of this item, as they retrospectively paid $16.28M to Bored Ghost Labs for producing Aave's v3. Aave divided the remaining $24 million across several separate firms that provided services to Aave.

The Balance Sheet

The tale of Aave's treasury is one we've heard before in the DeFi space: it's primarily made up of native tokens, which have been heavily impacted by recent drawdowns. Aave's treasury is divided into two sections: the environmental reserve and the central treasury. The ecosystem reserve is made up of AAVE tokens, which the protocol can use to reward liquidity mining or staking.

The central treasury, on the other side, is made up of token money received by Aave through fee collection. The central treasury is mostly made up of non-AAVE tokens, though the fee collector contract has earned some AAVE through fees.

When a DAO's treasury consists mostly of native tokens, the treasury value is prone to high fluctuation, as expected. The Aave treasury peaked at $1.65 billion and has since plummeted to about $143 million — a 91% drop.

Fortunately for Aave, $30 million of that treasury is in non-AAVE assets (mostly stablecoins).

aave treasury over-time

Source: Token terminal

Although $143M is a considerable sum of money, given Aave's burn, it is nonetheless causing concern. We are concerned that Aave's spending, particularly its third-party expenses, may be approaching the end of its runway. If Aave continues to spend at the same rate as in 2022, they appear to have only 24 months of runway left and significantly less if the price of AAVE falls. Aave could be wagering that the market will improve and income will rise throughout that time period, but it is a questionable assumption.

The Uncertainty

In terms of Aave's core competencies, the firm can earn a clear competitive advantage over its rivals thanks to a bevy of qualitative and nebulous attributes. The first advantage is that Aave possesses a strong brand, which is regarded as one of the most powerful in DeFi. Perhaps Uniswap and Curve are the only other names that are as well-known as Aave. A powerful brand image is represented by DeFi through the use of a color scheme that is primarily purple and an endearing ghost mascot. Although it is difficult to quantify, one should not discount how powerful Aave's brand is.

Aave has continuously had some of the best governance participation across all of the DeFi protocols that we have examined. This brings us to our second point. The discussion area is lively, with devoted individuals submitting replies and recommendations that have been carefully considered. Their snapshot votes typically have thousands of participants, whereas those of other organizations typically only have a few dozen. When we compare the results of the most recent ten Aave snapshot votes with those of other protocols, we can observe that there is a higher level of involvement.

Aave regularly has higher levels of participant engagement. Even while we have some reservations about the administration of the DAO in its current form, we cannot deny that Aave is clearly in the driver's seat in this regard.

Catalysts for New Growth

Despite the fact that Aave is having trouble generating cash, the company has some future releases that might assist raise revenue, attract more users to the platform, and ultimately help them construct their super-app.

Portal/Signaling for Cross-Chain Transactions

Additionally, the Portal functionality was added to the platform with the release of Aave version 3. Through the use of the Portal, authorized bridges are able to burn aTokens, also known as Ave deposit tokens, on one chain and then mint them on a different chain. The Portal enables cross-chain composability for Aave assets; it will also provide a significant amount of utility to GHO; and it will bring liquidity to a number of different chains. Users have the ability to mint GHO using their aTokens, make a deposit on Aave Ethereum, and shift their aTokens to Aave Polygon.

Given that the Aave app is already available on Ethereum, Polygon, Avalanche, Arbitrum, Fantom, and Optimism, it is possible that the Portal will make it possible for users of GHO and Aave depositors to travel easily between the several chains.

Lens Protocol

Lens Protocol, Aave's decentralized social graph, was released in the early part of 2022 and has been experiencing consistent expansion since then. Approximately 5,000 people utilize Lens every single day. Although this is not Aave's principal source of revenue, the fees that are generated from it are currently at a rather low level. Lens broadens the scope of Aave's product lineup and serves as a crucial component of the company's overarching strategy for developing the Web3 super-app.

GHO stablecoin

The advent of Aave's stablecoin, which they refer to as GHO, is the most exciting new development for the company. GHO will operate quite similarly to DAI in that it will take the form of a CDP model. Users will be able to mint GHO using the collateral that they have provided to Aave, and even when they are utilizing their deposited collateral to mint GHO, they will continue to earn interest on their placed collateral.

Aave is able to enter an entirely new market thanks to GHO. They will not only have a platform for lending money, but they will also have one that mints stablecoins based on deposits made by users. Stablecoins are added to Aave's platform and transaction audit trail all of a sudden, which poses a big challenge to MakerDAO and DAI. Even with a moderate LTV of 50%, Aave has the potential to quickly mint upwards of 2.5 billion GHO when it launches, despite the fact that it is more likely that Aave will gradually roll out GHO rather than all at once.

The current state

If one only considers Aave by itself, it is very simple to form a pessimistic outlook on the company due to the falling fee revenue and the substantial cash burn. However, as compared to its rivals, Aave is in a far stronger position than its rivals now are.

In terms of the total value locked, which for lending applications would primarily consist of deposits, Aave is currently in the dominant position in the market. Aave's most direct rival is Compound, which has a TVL that is significantly lower than Aave's. There are other competitors who play in completely other leagues. Although there have been major TVL reductions across the board, Aave continues to have a larger deposit base than its rivals do. At this point, it appears like Aave's dominance is practically impossible to challenge.

The same may be said for the number of active addresses on Aave. Aave recorded an average of 4,000 new addresses per day all through 2022. When compared to Compound, which posted an average of 205 new addresses per day, or Benqi's 501, it is clear that Aave is in the lead.

It is essential to keep in mind that Benqi, Gearbox, and Euler were released much more recently than Aave and have not had nearly as much opportunity to cultivate their respective user groups as Aave has. Despite this, the fact that Aave has greater usage stats paints a rather positive picture of the protocol overall.

aave and competitors

Source: Delphi Digital

It should come as no surprise that Aave has been able to sustain higher fee revenue than its rivals thanks to its significantly larger TVL and user base. In spite of the fact that Aave's fees have been decreasing over the course of 2022, as was detailed in the portion of this report devoted to revenue, Aave has maintained its lead over its rivals. Aave brought in an average of $517k per day in fees through the year 2022. Compound and Benqi, on the other hand, brought in $186 thousand and 105 thousand dollars, respectively. The revenue that Aave generates from its daily fees is roughly three times that of its closest competitor.

The above facts despite one thing 2022 was a difficult year for Aave. However, the company has managed to preserve and even strengthen its dominant position in the DeFi lending industry. Aave's moat is looking deep and wide.

When we consider how the macro environment may have an effect on Aave, it appears that the interest rates on traditional financial instruments will be one of the most significant obstacles for crypto-native money markets.

It's possible that Aave's revenue has been suffering as a result of rising TradFi rates. The goal of the majority of the world's central banks in 2022 was to reduce the pace of inflation by gradually raising interest rates throughout the year. At the end of December 2022, the effective rate of the federal funds rate was 4.1%. During the same time period, the best possible stablecoin rates on Aave fluctuated between 1% and 2% the whole year.

The value proposition of Aave is called into question by rising rates. The users have the option of holding a stablecoin or digital asset that is subject to regulatory uncertainty and depositing it in a lending protocol that is subject to solvency and smart contract risk for 1%, or they have the option of purchasing a T-bill or opening a savings account at 4.1%. Even while a significant portion of users have continued to participate in stablecoin and crypto-native money markets, it is not a good sign that a riskier market has lower interest rates than the "risk-free asset" that is considered to be the worldwide standard.

The interest rates that Aave charges on loans are determined by how much demand there is for borrowing money or leveraging. Because of how the market has been performing over the course of the previous year, the demand for leverage is significantly lower than it was in 2021 and the beginning of 2022. Because of this, the rates on Aave are consistently going to be cheaper. Aave's interest rates will return to more normal levels to reflect the required risk premium above traditional rates as demand for on-chain leverage continues to rise. This is what we can expect to see happen.

The possibility exists that the spread between TradFi and Aave may be reduced if Ondo Finance were to introduce T-bills onto the chain; however, this might not be viable on a large scale.

Conclusion

2022 was a trying year for Aave, but its competitors faced an even greater level of difficulty during that same year. Through 2022, Aave's revenue saw a downward trend, and the company is currently spending more than it is bringing in on a total basis. However, even after more than a year of unfavorable conditions, Aave still has 24 months of runway in front of it provided that prices and revenue do not fluctuate significantly.

Aave is in front of the pack when it comes to the number of users, income, developers, and TVL. Aave's governance is also more active, and its branding is among the most powerful in the industry. Aave is the leader in the field. Aave looks to be establishing a moat in spite of the many headwinds that it is facing, and it is highly improbable that we are looking at anything even remotely close to the end state for Aave.

Disclaimer:
This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.

GHO stablecoin is imminent: Examining the fundamentals of Aave