The following are all the businesses conducted by AAVE. Currently, it has carried out lending business on Ethereum, Avalanche, Optimism, Polygon, and Arbitrum. The businesses in the red box are Aave Arc (institutional licensed pool) in cooperation with institutions and RWA (Real-World Assets) in cooperation with Centrifuge.

Business Conducted by AAVE

1、Ave Arc

1.1 Why is an institutional licensing pool needed?

For some institutions, improving security and auditability may not be enough. For example, institutions subject to KYC/AML regulations cannot trade with anonymous counterparties. To address these challenges, "permissioned" protocols such as Aave Arc create lending pools consisting only of KYC counterparties, which can enable regulated institutions to participate in DeFi. These solutions may also be attractive to other institutions if the interest rates are higher than those in "permissionless" DeFi.

1.2 What is Aave Arc?

Aave Arc aims to provide such DeFi protocols with limited capabilities for institutional investors facing strict regulatory requirements. Arc will provide private pools where only participants who have passed the KYC process can access both borrowing and lending.

Below is a diagram of the Aave ARC economic system. Aave Arc is designed to be fully decentralized and managed by Aave Governance. Aave Protocol Governance can appoint or remove KYC and the "whitelist" of institutions and companies on Aave Arc.

Aave ARC economic system demonstration

On November 18, 2021, Fireblocks, a crypto asset custody platform and custody technology service provider, announced that it had submitted the Aave Improvement Proposal (AIP), becoming the first whitelisted party on Aave Arc (Fireblocks AIP). In December 2022, Fireblocks became the first company to obtain the highest level certification of the Cryptocurrency Security Standard (CCSS).

1.3 Fireblocks has a strong background

Fireblocks' mission is to bring more institutional participants into DeFi. Today, Fireblocks serves more than 600 customers and has secured more than $1.25 trillion in digital assets. Fireblocks' R&D, compliance, and legal teams have developed a new whitelist framework for permissioned DeFi. This framework meets both enterprise-level requirements for accessing DeFi and complies with Aave Arc's whitelist governance standards.

Fireblocks LLC is eligible to be whitelisted for Aave Arc because:

  • Licensed/registered entity in the jurisdiction in which it operates;

  • Comply with KYC/KYB principles in accordance with FATF guidelines;

  • A robust AML/CFT compliance program needs to be adopted and has been adopted.

Fireblocks LLC is a Delaware limited liability company (the “Company”) formed in October 2020 for the purpose of providing certain remittance services as a complement to its “Software as a Service (SaaS)” business. On April 13, 2021, Fireblocks LLC registered as a “Money Services Business” (“MSB”) with the Financial Crimes Enforcement Network (“FinCEN”), a U.S. federal regulator.

Various jurisdictions in the United States require companies to obtain a license to provide certain services, generally under applicable “money transmitter” statutes. Fireblocks LLC has obtained and is in the process of obtaining a state money transmitter license (“MTL”) (NMLS ID: 2066055) as required by state statutes and based on the activities, if any, that the Company intends to conduct in each state. The Company’s plans to pursue an MTL vary by jurisdiction and are subject to change.

Fireblocks Partners

Fireblocks has added 30 financial institutions to its “whitelist.” These institutions include Anubi Capital, Bluefire Capital (acquired by Galaxy Digital), Canvas Digital, Celsius, CoinShares, GSR, Hidden Road, Ribbit Capital, Covario, QCP Capital, and Wintermute.

Fireblocks provides secure, enterprise-grade, and easy-to-use access to decentralized exchanges and applications

  • With Fireblocks' DeFi API and browser extension, institutions can launch DeFi strategies without compromising security, operational or regulatory requirements. Fireblocks is now fully integrated into WalletConnect, which provides more secure access to DAPPs. Investors can access DeFi protocols and manage DeFi wallets directly through the secure Fireblocks platform, without downloading applications or wallets, and without having to keep their keys offline.

  • Fireblocks uses MPC (multi-party computation), SGX hardware defenses, and multi-user authentication workflows to protect assets in custody and in transit.

  • Investors can configure the platform to comply with internal procedures, such as limiting access to less mature protocols and setting limits by asset or role within the organization. Automated transaction logs and AML/KYC enable investors to meet compliance and auditability requirements.

Supporting assets

Four assets: ETH, WBTC, USDC, and AAVE. USDC is the only stablecoin offered on Aave Arc. USDC is strictly regulated and is a stablecoin suitable for institutions from a risk management perspective.

1.4 Other Projects

Aave Arc aims to bring institutions into the DeFi ecosystem, but it is not the only protocol launching products for institutional DeFi adoption.

Last year, Compound Treasury launched an institutional cash management solution powered by the Compound Protocol, providing daily liquidity for USD and USDC at 4.00% APR. Institutions can now use digital assets as collateral to borrow from Compound Treasury. Certified institutions can use Bitcoin, Ethereum, and supported ERC-20 assets as collateral to borrow USD or USDC at an interest rate of 6% per annum.

Compared with Aave Arc, Compound Treasury not only provides institutions with a fixed income platform in the crypto field, but also provides a US dollar lending platform for institutions holding some crypto assets.

Compared to the completely Aave V2-like experience that Aave Arc provides to institutions, Compound Treasury is more attractive to non-crypto financial institutions seeking a fixed rate of return in the crypto field. In addition, Compound Treasury also provides collateralized lending capabilities.

Summarize

  • Aave did not spend a lot of time and energy to comply with regulations and embrace supervision on its own, but chose to cooperate with third parties that already have a strong background, such as Fireblocks mentioned above. Fireblocks' main compliance focus is in the United States. It has the conditions of having registered MBS with FinCEN and obtained MTL licenses in various states in the United States (states with business). In addition to Fireblocks, Aave Arc will pass more whitelists in the future.

  • Aave Arc’s homepage is not open to the public, so ordinary users cannot see the current progress of the project.

  • The establishment of Aave Arc is of course of great value to the capture of Aave protocol revenue and can help Aave build a larger DeFi empire, but in essence the permissioned pool and the permissionless pool are separate and independent, because the counterparties in the permissioned pool are all institutions that have passed KYC, but they are not completely separate. The permissioned pool on Aave Arc may have different interest rates from the public pool on Aave V2, which will create arbitrage opportunities for those who have access to these two pools of funds.

  • Currently, it is not just Aave that is trying to embrace regulated compliant DeFi. Compound is also trying related fields. In the future, we may see more excellent DeFi protocols trying this field.

  • The practices of Aave and Compound are different from those of projects in the credit track. The main reason is the independence of institutional funds. They do not directly participate in public funds. Assuming that their market size is constantly growing, how many of them have actually entered the crypto market? This is still a question worth discussing.

2. RWA in partnership with Centrifuge

2.1 Why establish the RWA market?

RWAs (Real World Assets) have huge potential for DeFi in terms of volume, adoption, and risk diversification. As a pioneer in DeFi lending, Aave can bridge the regulated world of Tradfi with trustless DeFi. Centrifuge uses a new permissioned pool, and the functionality on Aave is designed to comply with AML regulations and US securities guidelines. The pool itself will run on Ethereum, but will only be accessible to KYC-verified users.

2.2 Founders of the RWA Market

Many people would think that the operator of this RWA market is Centrifuge, but in fact Centrifuge is just an infrastructure provider that enables asset originators to create on-chain asset funds through Tinlake to finance loans. Asset originators provide collateral assets to the licensed RWA market by adding their DROP tokens to the pool in exchange for DAI.

The permissioned RWA market is operated and managed by Series of END_Bridge LLC, an independent limited liability company. Independent means that END_Bridge is not owned, operated, and managed by Centrifuge. Limited partners need to pass KYC and sign a subscription agreement with END_Bridge. They are then whitelisted in the permissioned RWA market and receive aDROP for providing DAI.

Both Tradfi and DeFi are going through a process of innovation and learning. Aave is one of the pioneers in the community that is merging the two worlds together. Accepting RWAs in a closed environment as a permissioned pool is Aave’s first step towards wider adoption in traditional finance. The Centrifuge market is run separately from the Aave market to guarantee a secure environment and minimize protocol risk. Bringing in real businesses on one hand and institutions on the other will allow for the next iteration of DeFi.

2.3 What is Tinlake?

Tinlake is an open, smart contract-based asset pool marketplace that brings together asset originators and investors seeking to harness the full potential of DeFi. They do this by tokenizing their financial assets into non-fungible tokens (“NFTs”) and using these NFTs as collateral in their Tinlake pools to finance their assets. For each Tinlake pool, investors can invest in two different tokens: TIN and DROP. TIN, known as a “risk token,” carries the risk of default first, but also earns a higher return. DROP, known as a “yield token,” is protected by the default of the TIN token and earns a stable (but typically lower) return. This is similar to the junior/senior investment structure commonly seen in traditional finance. Each asset originator creates a pool for their assets and issues their own DROP and TIN tokens.

2.4 Mechanism of the RWA Market

On June 21, 2021, the Aave community initiated a proposal to establish a real-world asset (RWA) mortgage lending market, which suggested using Tinlake, a DeFi platform launched by Centrifuge, to establish the market.

On August 31, 2021, a proposal for Aave to add the Centrifuge real-world asset market was passed, according to which this market enables Aave depositors to earn yield against real-world collateral, while Centrifuge asset originators can borrow funds from Aave.

The goal of the RWA Market is to launch the first (permissioned) real-world asset (RWA) market on the Aave Protocol. This will allow Aave depositors to earn yield on stable, uncorrelated real-world collateral, while Centrifuge asset originators can borrow from Aave, automatically balancing capital needs and providing alternative collateral for volatile crypto assets. There are currently 8 pools on the Tinlake Protocol, ranging from real estate to supply chain financing to music streaming invoicing.

Both borrowers and lenders of RWA need to complete KYC. Only registered Tinlake Pools and asset issuers can deposit DROP tokens and borrow stablecoins in the RWA market. Lenders need to complete KYC and sign a subscription agreement with the issuer RWA Maket LLC.

Centrifuge's asset partners have all joined MakerDAO's MCD. This means that each pool has a corresponding contract vault on Maker and mints new DAI based on its DROP collateral tokens.

Regarding the price feed, each DROP token is linked to a Tinlake pool, which is a set of contracts. There is no secondary market for DROP tokens. The price of the token is calculated based on the NAV (Net Asset Value) and is updated every second. The DROP token price can be calculated from the Assessor contract.

The Aave V2 protocol uses the Chainlink aggregator as a price feed by default, with a fallback oracle. For DAI, the RWA market uses the same oracle setup as the DAI on Aave V2 market. For the DROP token, a dependable oracle contract is used, which retrieves the DROP token price from the Assessor contract.

2.5 Risk Setting

Unlike liquidations in DeFi, the Tinlake pool securitizes a portfolio of real-world assets, making the DROP token a very stable asset.

Tinlake's RWAs have a maturity date that indicates when the loan needs to be repaid. If the asset is not repaid by maturity, the asset sponsor will typically initiate a collection process to recover the funds. The worst-case scenario is that the asset defaults. The asset sponsor incorporates the expected default into its interest rate calculations and asset-specific prepayment rates (e.g., typically only financing 80-90% of the invoice face value).

In addition to expected defaults calculated via interest rates, all Tinlake pools provide downside protection via the (primary) TIN tranche. For example, if one invoice in a balanced portfolio defaults, the TIN investors will bear the loss first, without affecting the DROP investors. The price of the DROP token will only be affected if the default exceeds the pool-specific TIN ratio. If this happens, the pool will be frozen, meaning that asset originators cannot originate more loans until the funds are recovered to pay the DROP investors.

2.6 Market Performance

The current RWA market size is 7.92 million US dollars. Only one USDC market can still provide deposit and lending APY, and other markets no longer provide it. Users who successfully pass KYC only need to deposit USDC in the USDC market to obtain a 2.63% basic annualized return plus a 1.75% token incentive. This part of the incentive is issued in the form of wCFG. This rate of return is not particularly attractive in the current market.

RWA Market Size

Aave's RWA market is just one of the many markets on the Centrifuge Tinlake platform. Tinlake currently has 18 markets, 4 of which are about to be launched. The RWA market funds are independent of other markets. Tinlake's TVL totals 86.6 million DAI. Providing loans on Centrifuge also requires the same KYC as the RWA market.

Summarize

  • Centrifuge has designed a good mechanism for corporate financing, which not only serves enterprises but also provides more investment options for DeFi users. However, due to its small market size, Centrifuge needs to cooperate with more excellent DeFi protocols to expand this market, including Aave, MakerDao, etc. The cooperation with Aave brings real-world assets to more users, and Aave users also benefit from the loan interest given by the loan initiator.

  • The Centrifuge market operates separately from the Aave market, and the main companies behind them are also separate. This separation ensures a safe environment for the RWA market and minimizes protocol risks.

  • Like Aave Arc, the KYC of the RWA market is also outsourced to a third party. The KYC process is consistent with that of Centrifuge. Such an independent and licensed pool also represents a split between the non-licensed pool. Judging from market performance, it has not achieved good operational results.

  • Although the RWA market has a separate oracle contract for the price of Drop tokens, the price of Drop tokens does need to be directly linked to the price of real assets, including real estate, invoices, bonds, etc. These assets themselves have complex pricing mechanisms. When companies cannot repay funds, how can debt collection be completed? This requires the intervention of centralized operations. Although Centrifuge has introduced the concept of tiered funds, there are still systemic risks. In addition, this also represents the importance of perfecting the identity/reputation on the chain.