👻 AAVE: DeFi Money Market Juggernaut

Good Morning,

Welcome to another edition of our weekend issue: Breaking Down Businesses 📝

We’ll be taking a look at interesting companies or protocols, assess how they’re generating revenues, and guesstimate their earnings 📈

• What is it: Write-ups to better educate the broader crypto-web3 community on how various businesses and protocols are being run.

• What is it not: It is not a feature piece, we’re not going to be describing in great detail the entire background, origins, and history of the entities we cover.

• What is the goal: Give our readers a quick weekly download (10-minute read max) on the state of certain crypto businesses and protocols.

Let's get down to business.

P.S. Reply to this email to let us know what protocols/companies you want us to cover!

This week we’ll cover AAVE. The protocol was one of the first and is currently the largest lending-borrowing protocol in crypto. For many on-chain market participants, it’s an extremely familiar name. Yet, do you know that they're technically... not profitable?

P.S. The screenshots and numbers discussed in this issue were taken on February 28th, 2023.

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BREAKING DOWN BUSINESSES

AAVE: DeFi Money Market Juggernaut

Aave is a decentralized finance (DeFi) platform that operates on the Ethereum blockchain. It enables users to lend and borrow various crypto assets without the need for intermediaries. With Aave, users have full control over their funds at all times and can access various lending and borrowing options.

• One of Aave's unique features is its "flash loans", which allow users to borrow funds without collateral for a very short period of time. This has made it popular among arbitrage traders and developers looking to build new DeFi applications.

Aave has a native token called AAVE, which can be used for governance and to earn passive income. By staking AAVE, tokenholders can earn a 6-7% annual yield for helping to secure the protocol from any liquidity crisis. This yield isn’t without risk. In the scenario that there’s bad debt accumulated, the staked AAVE tokens can be slashed up to 30% 🗡️

Overall, Aave has become one of the most popular DeFi protocols in the industry, with billions of dollars in Total Value Locked. Thus far, Aave has consistently kept its position in the top 10 DeFi protocols ranked by TVL.

• It currently has $4.7B in TVL.

• At its peak in October 2021, Aave’s TVL reached $19B.

How Does AAVE Make Money?

Aave, like many other DeFi protocols, generates revenue through various fees charged on its platform. These fees are paid by users who participate in lending and borrowing activities on the Aave platform.

The fees charged by Aave vary depending on the specific activity being performed on the platform. It's worth noting that Aave's fees are subject to change and may vary based on market conditions and other factors, such as whether borrowers are using fixed or variable rates.

Here are some examples of the fees charged by Aave:

• Borrowing fee: Charged to borrowers who take out loans on the platform and typically ranges from 0.01% to 25% depending on the asset being borrowed, the loan-to-value ratio, and the length of the loan.

• Flash loan fee: Charged to users who use the "flash loan" feature on the platform, which allows them to borrow funds for a concise period of time without collateral. The fee is typically 0.09% of the amount borrowed.

• Other features fee: In V3, Aave will provide receive additional fees such as liquidation, instant liquidity, portal bridge, and many more.

In short, Aave earns revenues by charging fees to users of its services. These revenues are then put towards the Aave community treasury, whereby AAVE tokenholders have the power and ability to dictate how the funds are going to be utilized. These are done via governance votes on various proposals in the Aave’s governance forum.

• Aave has $131.9M in treasury as of 28 February 2023.

• 81.7% or $107.7M of Aave’s treasury is in the form of AAVE tokens, and the remaining 15.3% are in USD-denominated stablecoins.

• At its peak in Q2 2021, Aave’s treasury reached $1.03B.

If we look at the chart below, Aave has successfully maintained an average revenue of ~$20k per day in the past 6 months.

However, these figures are top-line revenue. Basically, it’s not extremely useful without understanding how much money Aave burns, either to pay its employees, and service providers or for token incentives.

Headcount and Burn

Aave has 117 employees according to Linkedln. Its top 5 “departments” are presented below:

• Engineering - 37 people

• Business Development - 22 people

• Finance - 12 people

• Arts and Design - 11 people

• Marketing - 9 people

Let’s create a scenario to guestimate how much Aave needs to spend on the 5 departments listed above:

• Engineering: At a $100k - $200k range, Aave needs to pay $3.7M - $7.4M per year.

• Business Development: At an $80k - $120k range, Aave needs $1.76M - $2.64M per year.

• Finance: At a $80k - $120k, Aave needs to pay $960k - $1.44M per year.

• Arts and Design: At a $60k - $90k range, Aave needs to pay $660k - $990k per year.

• Marketing: At a $50k - $80k range, Aave needs to pay $450k - $720k per year.

In total, for the 5 departments listed above, Aave needs to spend between $7.53M - $13.19M annually.

This excludes the remaining 26 employees that haven’t been included in the calculation. Assuming an average salary of $80k, AAVE needs to spend an additional $2.08M on these people. Pushing the final tally to $9.53M - $15.27M.

Additionally, data from Token Terminal stated that AAVE spent $124.67M in token incentives in 2022, adding another metric to its burn.

Earnings

Once again, credit to Token Terminal for doing the grunt work 👷⛏️

In 2022, Aave reportedly lost -$103.7M including its token emission spending to bootstrap or maintain liquidity, which is a crucial element of its services. If we include the additional $9.53M - $15.27M headcount burn calculated above:

While this might look extremely bad, given that Aave only has $120M - $130M in treasury capital left, there might be a silver lining in all of this.

• 👑 Aave is the de-facto leader in crypto lending-borrowing, with Compound being the closest competitor.

• ⬆️ Aave’s business model can still expand exponentially as it becomes a lot closer to a decentralized money market fund, especially with its upcoming GHO stablecoin which will act as a bedrock for even more innovative products.

• 👩‍⚖️ Aave barely scratch the institutional side of DeFi service, with its Aave Arc KYC-mandated pool failing miserably.

• 🏄 Aave’s earning in the past 3 months has shown a positive trend, compared to Q4 2022, indicating that the protocol is treading carefully in this bear market.

• 💼 Aave latest funding round was a $25M Series B in October 2020. In the worst case scenario, they can still raise for a Series C in the next few years.

What's Next

Aave launched its Version 3 in January 2023, with a focus on increasing its capital efficiency for lending-borrowing on stablecoins and liquid staking derivatives. Aave is also developing a stablecoin called GHO, a decentralized multi-collateral stablecoin that is fully backed, transparent, and native to the Aave Protocol. Right now, it is only active on the Aave platform on the testnet and has not been deployed to the mainnet.

With GHO and Version 3, Aave is positioning itself to become the go-to-market for lending-borrowing around stablecoins and liquid staking derivatives.

• Basically, the platform to lever up and rehypothecate your assets as the broader crypto industry moves towards Proof-of-Stake (hence staking yield), liquid staking derivatives, and stablecoins.

• By launching its own stablecoin, Aave expands its TAM and further cements its position as a DeFi juggernaut.

• Globally, money market funds hold ~$3 trillion.

What’s next: Aave needs to reduce its token incentives spending while maintaining its leading position by creating innovative products via its own stablecoin and LSD capital efficiency.

• Without its token incentives, Aave is approximately at a breakeven point considering its headcount and other operational costs. Just a bit more top-line or bottom-line adjustment, and the protocol should be profitable.

We predict that Aave’s final form will be much closer to a decentralized money-market juggernaut.

Until next time,

-Marco M.

Disclaimer: All the information presented in this publication and its affiliates is strictly for educational purposes only. It should not be construed or taken as financial, legal, investment, or any other form of advice.