Aave V4: Curbing Profit-Seeking Liquidity and Achieving a Sustainable DeFi Future

Author: ian.btc | 0xWorkhorse, compiled by Shaw Golden Finance

As Aave’s total locked value (TVL) soars to $70 billion, capturing over 80% of the DeFi lending market, the protocol is preparing to launch its most ambitious upgrade to date: Aave V4 - expected to be launched in the fourth quarter of 2025, and I am eagerly awaiting its arrival. As I mentioned earlier, the V4 upgrade introduces a hub-and-spoke architecture that addresses the “follow-for-profit liquidity” trap—where short-term capital pours in during incentive programs only to vanish once the rewards disappear—while laying the foundation for truly frictionless cross-chain operations. By centralizing liquidity, modularizing risk, and creating a path for institutional adoption, V4 positions Aave not only as a market leader, but also as a potential liquidity network for DeFi as a whole. Since the DeFi Summer liquidity yield craze of 2020, DeFi has been grappling with a structural flaw: profit-driven liquidity. DeFi protocols often rely on token issuance or yield incentives to attract capital, attracting liquidity providers (LPs) chasing high annualized interest rates (APRs). However, once returns gradually diminish, these funds flow to more profitable options. The result: unstable TVL, rising borrowing costs, and a fragile lending market. The post-2022 bear market was rife with this behavior—many incentive-driven forks and Layer-2 markets saw TVL plummet 80%-90% after the token issuance cliff. While participants like us benefited in the short term, the overall impact on the broader DeFi movement was not particularly positive. In short, this cycle undermines DeFi's promise of stability and decentralization. Despite its dominant position, with $28 billion in active loans and recently generating $15 million in monthly revenue from flash loans, interest, and liquidations, Aave faces similar challenges.

CEO Stani Kulechov recently highlighted the risks:

“We are proud of the work the Aave Labs team has done on Aave V4, our most ambitious release to date. After 18 months of design, we are addressing the core problem of liquidity head-on.”

V4’s solution lies in a reimagined architecture that prioritizes user retention over transient incentives.

Hub-and-Spokes: Reconstructing Liquidity for Stability

At the heart of Aave V4 is its Hub-and-Spokes model, a structural reform designed to eliminate liquidity fragmentation and speculation.

The liquidity hub acts as a centralized settlement layer, pooling funds and serving as the backbone of the protocol’s risk management, accounting, and governance. Spokes are modular extensions of credit lines connected through DAO governance, supporting specialized lending strategies—such as margin trading, AMM staking, or tokenized real-world assets (RWAs)—without creating isolated liquidity. This setup completely inverts the incentive model. Instead of chasing yield across decentralized pools, liquidity providers provide capital to a central hub, which dynamically allocates funds to various branches based on demand and risk parameters. A new reinvestment module automatically directs idle funds to low-risk, high-yield investment opportunities, further improving efficiency and increasing returns while reducing transaction costs. As Stani noted, this feature was added "on the fly," inspired by Ethena, allowing the protocol to deploy idle funds from the pool into highly liquid yield-generating strategies. Early simulations suggest this can improve capital efficiency by an astonishing 20%-30%.

All of this combines to form what Aave calls a "liquidity network effect." By concentrating funds in 1-3 hubs per network (e.g., tailored for stablecoins or volatile assets), V4 ensures that deep liquidity pools don't evaporate after incentives.

For participants like us, this means more stable returns; for borrowers, it means lower slippage and consistent access to funds. Governance as Guardrails With all of these technological innovations, it's worth noting that Aave V4's success hinges on its DAO-driven governance model, which replaces ad hoc incentives with (hopefully) structured control. In short, the DAO sets credit caps and risk parameters for each Spoke, ensuring liquidity allocation adheres to pre-set boundaries. This "risk ladder" approach, which segments Hubs by asset class—conservative for stablecoins and experimental for niche markets—ideally provides isolation from potential losses. For example, if a Spoke for a high-risk asset fails, its capped credit limit prevents the crisis from spreading to the Hub. This could prevent a $100 million loss like the one suffered by Mango on Solana in 2022—V4's limiting controls can contain losses. Therefore, when vulnerabilities inevitably occur, there are recourse. The improved liquidation engine further enhances resilience, effectively addresses undercollateralization issues, and protects core assets. This governance-first approach ensures V4 can support innovative use cases without sacrificing stability, a critical step in ending the boom-and-bust cycle of speculative capital. Economic Flywheel: Sustainable Returns Over Short-Term Profit Inducement Well, there's another key takeaway from addressing profit-seeking liquidity: V4's economic design. This is a significant step forward, truly breaking free from the constraints of profit-seeking, speculative liquidity. By aggregating funds in the Hub, Aave reduces the need for token issuance, which on competing platforms can account for over 50% of protocol expenses—a staggering amount. Instead, V4 introduces a revenue-sharing model with third-party Spokes. Developers building specialized markets—for example, Spokes for tokenized real estate or gaming assets—can tap into the Hub's liquidity while returning a portion of their fees to the DAO. This creates a flywheel effect: more Spokes attract more users, increasing Hub deposits and fee revenue, which in turn strengthens the DAO's treasury. Aave's current financials highlight its potential—year-to-date revenue of $86 million and buybacks of over 100,000 tokens, valued at approximately $27 million, have already reduced the circulating supply and boosted the token's value. V4's structure could further amplify this effect, potentially doubling fee revenue as new markets expand. More revenue means higher annualized yields and happier participants. While curbing yield-seeking liquidity may not be the primary focus of V4, I believe it will be a significant side effect that will fundamentally change how DeFi yields work. Furthermore, all of the above factors also attract institutional investors who have historically been wary of DeFi's volatility. By curbing speculative flows, liquidity hubs provide the deep, stable pools of capital that businesses need, similar to the market depth found in traditional finance. Features like segregated collateral vaults (compatible with custodians like Gnosis Safe) will allow institutions to participate without exposing their assets to volatile markets, while tight credit lines ensure predictable risk.

All of this is good for adoption and could potentially free up a lot of idle capital, as hedge funds and asset managers can use V4's infrastructure for arbitrage or lending on tokenized assets without having to worry about capital outflows after incentives are adjusted.

All in all, V4 is ambitious and exciting. In my opinion, its launch is likely to mark a major turning point in DeFi - and it will definitely mark a major change in the way I approach liquidity yield farming.