Aave News: Bank of Canada Study Says Aave V3 Avoided Bad Debt but Shifted Risk to Borrowers

TLDR

A Bank of Canada staff paper has found that Aave V3 reported no non-performing loans in 2024, with its Ethereum lending market avoiding lender losses through overcollateralization and automated liquidations. The study reviewed transaction-level data from Jan. 27, 2023, to May 6, 2025, and found that positions were generally liquidated before collateral values fell below the amount borrowed.

The paper said this structure helped contain lender losses across the period studied. Instead of relying on traditional credit analysis or borrower screening, Aave V3 used automated risk controls that required users to post collateral exceeding the value of their borrowings. When positions breached set thresholds, liquidations were triggered automatically.

According to the report, that framework prevented the recovery of bad debt during the sample period. At the same time, the paper said the system did not remove risk from the lending model. Instead, it transferred much of that risk to borrowers, especially during sharp market moves that forced liquidations at unfavorable prices.

The findings add another layer to the current discussion around decentralized lending as Aave expands its protocol design. Aave V4 recently went live on Ethereum after a governance vote, introducing a new architecture meant to separate liquidity and risk across markets while supporting a wider range of collateral and risk-based borrowing conditions.

Study Finds Borrowers Bore the Cost of Liquidation Events

The Bank of Canada paper said that the absence of bad debt in Aave V3 came with a clear trade-off. While lenders were protected from losses tied to unpaid loans, borrowers faced abrupt losses when collateral prices fell quickly. The report said liquidation fees typically ranged from 5% to 10% of liquidated value, while lost gains from later price rebounds pushed combined borrower losses to around 10% to 30% in some cases.

The study also found that liquidations tended to occur in concentrated waves rather than in a smooth pattern. Four assets accounted for about 90% of total liquidated value during the sample period: Wrapped Ether, Wrapped Staked Ether, Wrapped Bitcoin, and Wrapped eETH. That concentration showed how borrowing risk could become linked to a relatively small group of major crypto assets.

The paper described Aave V3’s structure as effective in preventing lender-side impairment, but less efficient from the borrower side. Compared with more traditional lending systems, the model required borrowers to pledge larger amounts of collateral and to accept the risk of automated liquidation as market volatility increased.

Recursive Leverage Played a Major Role in Borrowing Demand

Another key finding in the study was that borrowing activity on Aave V3 was not driven only by users seeking liquidity for spending or operations. The paper said that recursive leverage accounted for more than 20% of the total borrowed volume and 8.2% of all borrowing transactions during the period examined.

Recursive leverage refers to users borrowing against collateral, redeploying the borrowed assets as new collateral, and borrowing again to increase exposure. The report said this behavior raised market sensitivity because these positions became more vulnerable once prices moved lower and liquidation thresholds were hit.

That matters because it changes how activity on decentralized lending platforms is interpreted. Borrowing demand can reflect leveraged market positioning rather than real-world credit demand, meaning liquidation cycles can intensify as asset prices fall. In Aave V3, that effect appeared in the concentrated liquidation episodes identified in the paper.

Aave V4 Launch and AAVE Price Keep Market Focus on Risk Structure

The study arrives as Aave pushes ahead with V4 on Ethereum. The new version introduces a hub-and-spoke architecture designed to separate liquidity and risk across markets. It also adds a credit framework that supports different collateral types and risk-based borrowing rates. The rollout is being phased, with early restrictions on asset availability and set limits across markets to monitor liquidity and system behavior.

In the market, AAVE was trading around $95.38, up 0.54% over the past 24 hours based on the material provided. Short-term price action showed a recovery after dipping into the $94.00 to $94.20 area, with immediate support near $94.80 to $95.00 and near-term resistance around $95.50 to $95.70.

Source:  X

On the broader chart, AAVE had already broken below the $114 support and then lost the $100 level, which is now being watched as resistance. The next major support area was identified near $80.60 if the breakdown remains in place.

The post Aave News: Bank of Canada Study Says Aave V3 Avoided Bad Debt but Shifted Risk to Borrowers appeared first on CoinCentral.