A Bank of Canada staff paper found Aave V3 reported zero non-performing loans in 2024, attributing this to overcollateralization and automated liquidations that helped prevent lender losses in its Ethereum lending market. Using transaction-level data from Jan. 27, 2023, to May 6, 2025, the study found positions were generally liquidated before collateral values fell below outstanding debt, containing lender losses across the sample.
The paper noted a tradeoff: while Aave V3’s design protected lenders from unrecovered losses, it shifted risk to borrowers and reduced capital efficiency compared with traditional lending. The protocol relies on automated risk controls rather than underwriting, requiring borrowers to post more collateral than they borrow and triggering liquidations when risk thresholds are breached.
Recursive leverage was a significant driver of activity: the paper estimates it accounted for over 20% of total borrowed volume and 8.2% of borrowing transactions in the sample. Recursive leverage—repeatedly borrowing against collateral, redeploying borrowed assets as new collateral, and borrowing again—amplifies exposure and increases borrower vulnerability when markets turn.
Liquidations on Aave V3 tended to occur in concentrated waves, with four assets—Wrapped Ether (WETH), Wrapped Staked Ether (wstETH), Wrapped Bitcoin (WBTC) and Wrapped eETH (weETH)—making up about 90% of total liquidated value. The paper estimated liquidation fees typically ranged from 5% to 10% of liquidated value; missed gains from subsequent price recoveries could push combined losses to roughly 10%–30% in some events. Thus, while the design prevented unrecovered bad debt in the sample, it exposed borrowers to abrupt and sometimes large losses when collateral prices fell sharply.
Cointelegraph contacted Aave for comment but did not receive a response before publication.
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