Aave is one of the projects that I have been following for a long time. Yesterday, its governance team ACI released a draft of the new economic model of Aave on the community forum, announcing expected upgrades in the value capture of Aave Token, security mode of the protocol, and other aspects.

Regarding Aave, the author's recent article provides a comprehensive analysis of its recent situation, competitiveness, and valuation: 'AltCoin keeps falling, or is it the best time to layout Decentralized Finance'.

The author of this article focuses on this hugely influential latest proposal, mainly addressing the following 4 questions:

1. What are the main contents of this proposal

2. Potential impacts of each major content

3. The schedule and triggering conditions for the implementation of this proposal

4. How may this proposal affect the price of Aave Token in the medium to long term?

Original proposal:

1. Core content of AAVEnomics proposal

The proposal is called [TEMP CHECK] AAVEnomics update, which is in the early stage of community proposal, namely the 'temperature check' stage. It was released 15 hours ago and initiated by ACI, who can be understood as the governance representative of Aave official team. ACI is also the brain and main coordinator of community governance. Important proposals are usually communicated extensively with other governance representatives and professional service providers before release, so the probability is high.

[TEMP CHECK] The main content of AAVEnomics update is as follows:

1. Introduces Aave's current good operating status and ample financial reserves

The project is in a continuous leading position in the lending field, with income far exceeding project expenses, and the reserve funds are long ETH and stable coins, so it has the opportunity to update the economic model and initiate protocol income distribution.

2. Bad debt processing mechanism update: The original "Security Module" is gradually exiting the stage, and the new security system Umbrella is online.

Aave currently provides reserves for potential protocol bad debts, and this mechanism is called the 'Safety Module'. The reserves are currently composed of three parts:

· Aave's stake is currently worth $275 million.

· Stake Aave's native Stable Coin GHO, currently worth $60 million

· The Aave-ETH LP for stake is also a major source of on-chain Liquidity for Aave, currently valued at 1.24 billion US dollars

The newly launched 'Umbrella' security system will replace the original security module, specifically:

· The bad debt reserve of the system will be managed by the new aToken module, which is funded by users who voluntarily deposit their funds. After depositing, users will not only receive interest on their original deposits, but also receive additional security subsidies. The subsidies come from Aave's protocol revenue.

3. The new role of Aave Token and the start of protocol profit sharing distribution

The Aave stake module still exists, but Aave no longer serves as the risk reserve for stake, but has two functions:

· Can obtain the profit surplus distribution of the protocol beyond the funds needed for operation reserve, by Aave's financial team repurchasing Aave in the Secondary Market and distributing it to the depositors through community governance proposals on a regular basis.

· Staking Aave can earn 'Anti-GHO', which can be used to offset your GHO Stable Coin debt, or directly deposited into the GHO stake module, so Aave can also benefit from the profits generated by GHO.

4. Changes to the GHO stake module

The original GHO stake module needed to guarantee the overall default of the Aave protocol system, but after the change, it only guarantees the default of the GHO part.

5. Others

· Aave Token's Liquidity no longer depends on the stake module's Aave - ETH incentives, but is entrusted to the ALC (Aave Liquidity Committee)

The conversion of the first generation Token Lend of the protocol to Aave will be terminated, and Tokens that are not exchanged in time will be transferred to the national treasury.

Aave's new economic model relationship diagram is visible:

2. Impact of this proposal

The main impacts are twofold:

Aave Token has a relatively clear value capture, and the selling pressure further drops, further linked to the good development of the protocol

· Value capture comes from: protocolInterest Spread part of the income buyback + GHO Interest income feedback

· The decrease in selling pressure comes from: the deactivation of the stake module, which also means that Aave will use stablecoins and ETH as expenditure tokens for protocol income, instead of producing Aave tokens, which will directly reduce the selling pressure of Aave and make Aave more scarce.

The introduction of the Umbrella Security Module makes the structure of the protocol more flexible, further optimizing the incentive of the protocol, further enhancing the upper limit of the protocol's security governance, and proposing higher governance requirements:

· The original Aave security module is solely based on Aave emissions for incentives, with little flexibility, while the Umbrella security module is similar to Eigenlayer's AVS mode, a modular, customizable incentive module based on asset class, time, and capacity.

· This also means that Aave's risk team has added another indicator that needs to be evaluated and formulated, in addition to risk indicators such as asset size, Interest Rate curve, and LTV.

3. Schedule and Prerequisites for Implementation

ACI stated that the implementation of the plan will be carried out gradually in three phases (three governance proposals) based on different preconditions.

Phase One: Stake and GHO Mechanism Modifications

· GHO stake is only responsible for the bad debt guarantee of GHO debt.

· Aave and Aave - ETH stake module has been changed to "Legacy Security Module", and continues to provide collateral function before being replaced, Aave stake's cooldown period is set to 0

Prerequisite: Achieved

Execution time: This proposal has obtained sufficient community opinions and has been approved by BGD Labs, the main community developer of Aave, after the Umbrella upgrade.

Phase Two: Aave Token functionality update, new economic model gradually launched

· End stake Aave to receive GHO Interest

· Discount function Anti-GHO function online, stake Aave can get Anti-GHO

· Close Lend to Aave exchange

Prerequisite:

· GHO has reached a scale of 175 million (currently around 100 million)

· GHO's secondary Liquidity can achieve 'a trading volume of 10 million with a price impact of less than 1%'. Currently, the trading volume that affects GHO's price by 1% is around 2.1 million.

Phase 3: Aave Fee Switch Activated, Buyback Initiated

· Close traditional security module

· With the aToken mode activated, users can use their deposits as collateral for the system and receive additional rewards.

· Aave financial service providers initiate Aave repurchases and allocate them to Aave stakers through governance, gradually achieving automation.

Prerequisite:

The average asset net value of Aave's income pool in the past 30 days is sufficient to cover the expenses of existing service providers for 2 years.

*Currently, the total assets in the Aave treasury excluding Aave Token are approximately $67 million (61% stablecoins, 25% ETH, 3% BTC), and Aave's annual expenditure in 2024 is about $35 million (data provided by the ACI leader). If the expenditure level in 2025 is similar, the two-year expenditure will be $70 million. Considering that Aave's weekly income has been basically between 1-2 million US dollars since this year, the two are already quite close and can reach this level in about a month.

Composition of Aave's treasury funds, source:

Aave's protocol income, source:

· The annualized income of the Aave protocol in the past 90 days has reached 150% of all protocol expenses from the beginning of the year to the present, including the buyback budget of AAVE and the expenditure of the umbrella security module.

*The budget is defined, allocated, and adjusted quarterly by Aave Finance service providers.

In general, Phase 1 is already ready to go live, and Phase 2 is expected to take a few more months (specifically depending on the Liquidity Committee's budget and investment intensity for GHO's Liquidity). The timing of Phase 3 going live is difficult to predict, as it is influenced by specific budget plans, market conditions, and income factors, but considering Aave's strong revenue level at present, meeting the standards shouldn't be too difficult.

Four, how will this proposal affect the price of Aave Token in the medium to long term

In the long run, the proposal explicitly links the development of the Aave protocol for the first time with the Aave Token, providing a buyback floor for the Aave Token and cash flow income for holders, bringing Favourable Information to Aave's price.

However, considering that the implementation of the proposal takes time and is carried out in batches, coupled with the fact that the proposal was just released less than a day ago, there is still a need for discussion and modification on specific terms, so the value capture of Aave Token is a gradual and long-term process.

However, if the proposal is successfully implemented, Aave, as one of the largest Defi projects at present, may further gain favor from value investors with its standardized and transparent governance, and rewards for Token supporters. These investors may come not only from the crypto world, but also from newcomers in the Web3 field originating from the TradFi sector.