Revitalizing Crypto Lending

Credit and lending markets play a crucial role in traditional finance (TradFi), providing the funds that fuel economic growth and help individuals and businesses achieve their goals.

However, moving credit markets onto the blockchain in the world of decentralized finance (DeFi) has been a slower process with only a few strong players emerging so far. In the crypto space, collateral-backed lending has become the predominant model where digital assets are used as collateral to secure loans.

In this edition of the Crypto Market Monitor, we'll dive into the current landscape of onchain lending markets and see why Aave may remain the sector leader in this cycle.?

The State of Crypto Lending Markets?

In 2023, traditional finance (TradFi) yields were on the rise, while onchain yields for crypto lagged behind the risk-off bond market. This disparity was due to lower demand for liquidity and a risk-off environment driven by rising interest rates. As treasury rates increased, protocols like Tether and Maker skillfully leveraged their stablecoin reserves to capitalize on the higher offchain risk-free rates.

At the same time, crypto users adopted a more risk-averse approach and Liquid Staking Tokens (LSTs) — where users lock their native tokens like ETH in exchange for a yield-bearing derivative token used in DeFi —gained popularity for onchain yield generation. As we now anticipate a stronger bull market and a declining macro interest rate environment, we believe onchain debt markets are set for growth.?

Not surprisingly, at the time of writing, Lending is the biggest sector by total value locked (TVL) at $37.5 billion, followed by cross-chain Bridges ($26.6 billion) and Decentralised Exchanges – DEXes ($22.4 billion). Protocols compete to attract liquidity in crypto and it does not get bigger than Lending market.

Any protocol would want to be the biggest in the sector because it comes with major perks. Being the leader boosts market influence and brand recognition as the biggest fish in the sea, attracting even more users due to its credibility, investors, and partners. Economies of scale help cut costs and boost profit margins, while network effects mean the platform's value grows as more people use it. Let's dive into a comparison of the various protocols within the Lending sector.?

A total of 418 protocols currently operate in the Lending space. In terms of TVL, Aave leads the pack with close to $13.5 billion in TVL, followed by JustLend on the Tron chain ($6.7 billion TVL) and Maker’s Spark protocol ($3.2 billion). These are followed by Compound Finance and Venus protocol. In Q1 2024, the sector’s TVL grew by over 47%. However, due to a market-wide slowdown and a drop in crypto prices, Q2 growth is currently at just 5% due to the recent decline in crypto prices.??

Figure 1: TVL progression of the top 5 lending protocols in DeFi

Within this sector, Aave is more or less the major player to watch. According to data from Token Terminal, close to $12 billion in active loans exists in DeFi across lending protocols. The ones leading the pack are Aave and Spark protocol, followed by Morpho, Compound and Venus protocol.

Even in terms of fees earned, Aave has a massive lead with close to $367 million in annualised fees and its closest competitor is Morpho. ($86 million) However,it’s not all sunshine and rainbows for Aave. The protocol is giving out major token incentives for its users – close to $1.2 million over the past 30 days and has the highest expense among top lending projects. ?

Figure 2: Active loans by protocol?

In 2023, Maker, the provider of collateralized debt positions and issuer of the DAI stablecoin, achieved the highest profits among all protocols. This success came mainly from the protocol's ability to generate offchain yield through real-world assets (RWAs), even as onchain user interest waned. Currently, RWAs constitute about 45% of Maker's total portfolio. However, with declining TradFi yields and increasing demand for stablecoins onchain, the landscape is shifting as more users look for the same yields onchain.?

Aave all the way??

As the leading lending market, Aave is seeing phenomenal growth and user demand in 2024. The demand for stablecoins onchain is evident from the yield leaderboard chart below (Figure 4) across different pools on Aave on different chains. Clearly, users are borrowing more to build asset-denominated positions on top of their borrowings.

The variable borrow rate is an interest rate that changes with market demand, providing users with potentially lower borrowing costs but increased risk due to rate fluctuations. With users currently getting more risk-tolerant, there has been a steady rise in this metric across stablecoins on the protocol according to data from Glassnode.??

Figure 3: Variable borrow rates for stablecoins on Aave V3?

This increase in demand for stablecoin borrowing is also accompanied by a drop in the rate at which these loans are being repaid. A way to measure the level of repaid loans is to look at utilisation rates of the respective lending pools. This is the proportion of borrowed funds in the lending pool compared to total funds available for borrowing.

This rate is usually expressed as a percentage and is an important indicator that reflects the liquidity situation in the pool. A high utilisation rate means that the token is in demand and lesser borrowers are repaying their loans. Not surprisingly, the highest utilisation rates on Aave V3 on Ethereum are for stablecoins. This is led by DAI (93.99%) followed by USDC (91.22%), USDT (90.62%) and FRAX (88.07%). The next in line is WETH at 79.93% - at a substantially lower utilisation rate compared to top stables.?

Figure 4: Stablecoin pools form the major chunk of top lending pools by utilisation rate on Aave V3 on Ethereum?

?In comparison, Spark protocol on Ethereum has lower total stablecoin deposits barring DAI which is its native stablecoin. For instance, total USDC supplied on Spark is $2.57 million (vs $1.4 billion on Aave V3) and total USDT supplied is a mere $203K (vs $1.3 billion on Aave V3). This is despite similar utilisation levels for the respective stablecoin lending pools between the two giants. This means that demand for stables is similar across the two leading protocols – Aave and Spark. However, users are operating much more on Aave than on Spark.?

But is the high TVL and lending activity from a select few whales? Is this difference a result of the average user position on Aave being substantially larger than that on Spark? Are the number of users of the two protocols comparable? That does not seem to be the case. Aave has the highest user base among all lending protocols and is currently averaging roughly 6.3K daily active users – close to 150% that of Spark which has a daily user count of roughly 4.2K. This leads us to conclude that across metrics, Aave is a much larger protocol than Maker and has more to gain from a strengthening bull market as demand for borrowing rises.?

Aave has also tapped into newer narratives and has lending markets for Liquid Staking and Restaking Tokens. (LSDs and LRTs) Right now, Aave is at an exciting turning point. With markets on the mend and expected interest rate cuts later this year, Aave is set for a rapid boost in borrowing and lending activities. Its knack for attracting and keeping high-value users, highlighted by significant capital coming in shows just how strong Aave is as a leading DeFi lending platform and its potential to shape the market in the coming year.?

To get our research updates directly in your inbox, #subscribe to our newsletter at ?? https://lnkd.in/dJctS-E8