Detailed explanation of Aave V4: How can the lending leader rebuild its moat?

Author: Matt , Researcher at Castle Labs

Compiled by: Tim, PANews

At the Ethereum Community Conference (ETHCC), Aave founder Stani announced that the new version of the protocol Aave V4 will be released soon. As the largest lending protocol in the DeFi field, this iteration has attracted much attention from the market.

Today, I will focus on the functional updates of the Aave V4 protocol, especially how the new interest rate parameters and the GHO stablecoin upgrade reconstruct the protocol ecosystem. These innovative measures may profoundly change the capital efficiency model. After the liquidity pool adopts a dynamic spread mechanism, the lending rate will achieve market-driven pricing for the first time; and GHO's cross-chain enhancement module will not only improve the practicality of stablecoins, but also optimize the on-chain liquidation of debt positions, building a new financial infrastructure for the entire protocol.

What is AAVE V4?

Aave's total locked value exceeded the $25 billion mark for the first time, becoming the first lending protocol in the DeFi field to reach this milestone. Its development team is actively promoting the development of new features to further drive platform growth through risk parameter adjustments.

New features announced last year are coming soon:

• Unified liquidity layer: Introducing a series of modules to remove the original restrictions on liquidity migration, while adding new features such as cross-chain lending.
• Fuzzy Control Interest Rate: This mechanism automatically adjusts the interest rate curve and inflection points based on market conditions rather than relying on governance voting.

Liquidity Premium: Borrowing costs will be more dependent on the liquidity of each token. Assets such as ETH will remain at no premium and become the base currency, while other assets such as WBTC and wstETH will adopt corresponding premium mechanisms based on their liquidity conditions.

Aave V4 lending module: The team is exploring the use of smart accounts to support features such as Aave vaults, which can lock liquidity, disable collateral functions, etc.

Dynamic risk configuration: The collateral ratio is linked to the market state when the position is established, rather than subsequent market fluctuations, providing greater stability for user positions.

• Automated asset offline
• Automated money management
• Liquidation Engine V4: Aave’s liquidation mechanism is undergoing a major upgrade, including variable liquidation parameters and reward mechanisms, while also supporting batch liquidation functionality.
• Deeper GHO integration: GHO will achieve deeper native integration in Aave V4, including soft liquidation mechanism upgrades, stablecoin interest payment in GHO, new emergency redemption mechanism, and other optimization functions.
• Additional upgrades include gas fee optimization and deprecation of features such as tokenized positions and stable interest rates.

Now let’s take a closer look at two important changes: the unified liquidity layer and the GHO upgrade.

Unified Liquidity Layer

The Unified Liquidity Layer introduces a new chain-agnostic, independent, and abstracted liquidity infrastructure.

A major improvement of this modular system is that new lending modules can be deployed or old lending modules can be offline without migrating liquidity.

This architecture supports adding or optimizing lending functions (such as isolated fund pools, physical asset modules, and mortgage debt positions) without changing the overall system and clearing module. At the same time, it effectively solves the liquidity fragmentation problem that existed in the early version of the protocol.

The liquidity layer supports both user-provided and natively minted assets, improving integration with GHO and other cryptocurrencies collateralized by Aave protocol native assets.

Cross-chain lending may be one of the most influential functional modules, where users can deposit on one chain and borrow on another chain. This not only significantly enhances the platform's cross-chain liquidity potential, but also creates new opportunities for market growth.

GHO Upgrade

GHO is an over-collateralized stablecoin launched by Aave, with a current market value of over $220 million and a 53% increase since the beginning of 2025.

In addition to minor improvements such as improving the efficiency of native coin minting, the most eye-catching upgrade is the introduction of a flexible liquidation mechanism. This mechanism draws on the innovative model of crvUSD and streamlines the liquidation process through a lending and liquidation automated market maker (LLAMM).

Liquidation operations are performed within a customizable range, and the mechanism guides the system to convert assets into GHO when the market falls and repurchase collateral when it rises. Compared with crvUSD, Aave V4 has three major advantages: users can independently select collateral for liquidating positions from the asset basket; they can freely choose the repurchased collateral from all available assets on the Aave platform (including assets not initially provided); and they can also enjoy the benefits of GHO automatically generating interest income.

Another notable change is that stablecoin market users are able to receive interest payments in the form of GHO, a mechanism that expands the supply of GHO by converting interest directly into tokens.

Aave V4 introduces an emergency redemption mechanism to deal with the extreme situation of severe and continuous depegging of GHO. Once the mechanism is triggered, the platform will gradually exchange the collateral position assets with the lowest health coefficient into GHO tokens based on the innovative LLAMM design to repay user debts.

Conclusion

For a protocol of Aave’s size and importance, minimizing risk is critical, especially when launching major features like cross-chain lending.

Automating processes such as delisting assets and adjusting interest rate models can help reduce reliance on slow DAO processes, especially when responding to market-driven changes.

Aave is confident in the growth of its GHO stablecoin, which is currently receiving significant improvements and deeper integration in the protocol.

Aave is expected to remain a cornerstone of the DeFi space for the foreseeable future. The success of the broader ecosystem is highly dependent on its continued leadership. After all, no other project has been able to accumulate this level of total locked value while maintaining the same level of security.