A Bank of Canada staff document shows Ave V3 recorded zero non-performing loans in 2024, with overcollateralization and automatic liquidations helping prevent lender losses in the Ethereum lending market.
Using transaction-level data from January 27, 2023 to May 6, 2025, test found that positions were typically liquidated before the value of the collateral fell below the outstanding debt, which helped limit losses for lenders across the sample.
However, the newspaper reports that this model involved a certain compromise. While it protected lenders from unrecovered losses, it also transferred risk to borrowers and reduced capital efficiency compared to customary lending systems.
According to the article, Aave V3 is designed around automated risk control rather than customary underwriting, requiring borrowers to post more collateral than they lend and liquidating positions when risk thresholds are exceeded.
Recursive leverage drove demand for loans
According to the article, Aave V3’s lending activity was not solely driven by users seeking liquidity. It found that recursive leverage accounted for more than 20% of total borrowed funds volume and 8.2% of borrowing transactions during the sample period.
Recursive leverage involves borrowing against collateral repeatedly, redeploying the borrowed assets as novel collateral, and borrowing again to raise exposure.
Related: Aave V4 launches on Ethereum after board approval of the implementation
The study found that these dynamics made borrowers more vulnerable to risk when markets turned. According to the article, Aave V3 liquidations typically occurred in concentrated waves, with four assets accounting for 90% of the total liquidation value.
This includes wrapped ether (WETH), wrapped stacked ether (wstETH), wrapped bitcoin (WBTC), and wrapped eETH (weETH).
The article estimated that borrowers’ losses in major liquidations could be significant. Liquidation fees were found to typically range from 5% to 10% of the liquidated value, while lost profits from subsequent price recoveries in some cases resulted in total losses rising to around 10% to 30%.
The staff paper suggested that while the Aave V3 project helped prevent unrecovered bad debts in the sample, it did so by exposing borrowers to sudden losses if security prices plummeted.
Cointelegraph reached out to Aave for comment but did not receive a response prior to publication.
Warehouse: Are DeFi creators responsible for other people’s illegal activities on their platforms?
