【ChainNews Selection】What is AaveLEND's credit delegation mechanism? Riding the liquidity mining program leads to a surge

The original title is "Aave COO Confirms Liquidity Mining Plan and Details Bold Out-of-Circle Exploration", written by Chain News LeftOfCenter

The hot trend of liquidity mining in decentralized finance products has become a focal point in the market. Chain News has learned that Aave, a decentralized lending platform with a rapidly growing locked asset value, is also planning to launch a liquidity mining program. Aave's Chief Operating Officer Jordan Lazaro Gustave confirmed to Chain News, "We will soon announce a new token economic model, which will include plans for liquidity rewards and Lend token staking rewards."

As the current token Lend issued by Aave is already in circulation, the key focus of the new economic model design is how to distribute new tokens to liquidity providers through liquidity mining. Jordan Lazaro Gustave revealed that the platform will introduce a brand new token AAVE, replacing the current Lend token through token swap. The economic model designed for the new token AAVE will include mechanisms for liquidity rewards and token staking rewards.

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Jordan Lazaro Gustave declined to reveal more details about the newly designed economic model.

In addition, Jordan Lazaro Gustave introduced the newly launched "Credit Delegation Mechanism" to Chain News. He stated that the new "Credit Delegation Mechanism" not only incentivizes the generation of more DeFi liquidity funds, expanding the overall scale of DeFi funds, but more importantly, aims to utilize the liquidity in DeFi for traditional financial market enterprises, extending the influence of DeFi beyond the crypto world.

He mentioned that Aave's protocol's longer-term goal is to become foundational infrastructure, providing liquidity for traditional markets in a transparent and open manner.

So, how will this mechanism achieve a cold start? What are the potential risks of this credit delegation mechanism? Aave COO Jordan Lazaro Gustave detailed the design concept to Chain News, unraveling these mysteries for us.

What is Credit Delegation?

Credit Delegation mechanism refers to the ability of depositors on Aave to delegate their idle credit lines to others, earning higher interest rates, while allowing borrowers to borrow without collateral, effectively reducing the inefficiency problem of capital utilization in DeFi that has been difficult to solve.

For Aave users, depositors can still deposit assets like USDT into Aave as usual, but with the added Credit Delegation feature, they can delegate their credit lines to others in need of loans.

The Credit Delegation feature will be integrated with OpenLaw, meaning that to ensure the enforceability of the agreement, both the delegator and the borrower need to negotiate and govern the unsecured loan agreement based on OpenLaw.

The Entire Process and Implementation Details

Let's use Karen and Chad as an example to demonstrate how the entire Credit Delegation process works:

Assuming Karen is a depositor with idle funds, and Chad is a borrower in need of a loan, they can establish loan terms such as repayment, interest rates, and repayment periods through the OpenLaw platform. This agreement ensures the enforceability of the loan, similar to using DocuSign for agreements.

After signing the agreement, Karen can deposit her assets (e.g., 1 million USDT) into the Aave platform and receive an equivalent amount of aUSDT.

Next, Karen needs to create a Credit Delegation Vault (CDV) smart contract that allows her to deposit 1 million USD worth of aUSDT and set various parameters, including the credit limit.

For example, setting an 8% APR based on the OpenLaw agreement reached between Karen and Chad. Once the agreement is accepted and signed, Karen will add Chad's receiving address to the CDV whitelist, allowing Chad to borrow 750,000 USD worth of ETH from the Vault against the credit limit without collateral. It is important to note that there is a 3% stability fee for ETH, deducted from Karen.

For the borrower, Chad can access the credit limit through the borrow function and repay it through repay(). The open credit limit provides flexibility for Chad.

By delegating her idle credit line to the borrower, Karen can earn a higher loan interest rate than before. In this case, Karen's annualized rate is 10% (5%-3%+8%), while Chad can extract 750,000 USD worth of liquidity from Aave at 8% annualized rate without collateral.

Why is it Important?

Essentially, Credit Delegation is akin to decoupling and selling idle credit lines to others, with benefits for both parties. Depositors can customize interest rates, meaning they can earn higher risk returns if they are willing to take on more risk. Borrowers only need to pay interest fees without collateral, increasing capital utilization.

Although "unsecured" loans may seem to introduce systemic risks to the protocol, they are only valid for borrowers. At the system level, every "unsecured" loan on Aave is still backed by excess collateral. In fact, the credit risk of issuing the loan is borne by the delegator.

Initially, Credit Delegation will be limited to acquaintances or entities with good reputations, which means the feature will start with trusted relationships to reduce default risks.

According to Stani Kulechov, the founder of Aave, in the early stages, Aave will launch the Credit Delegation model with existing OTC loan participants. This means that Aave aims to introduce OTC enterprise clients into DeFi as counterparties through the Credit Delegation mechanism, where delegators are mainly cryptocurrency funds, and borrowers are market makers and exchanges. Since both parties have had years of OTC business connections, reaching consensus is not only easier but also facilitates due diligence.

This indicates that at the early stage, the Credit Delegation mechanism will be implemented through trusted relationships in a cold start manner, making the transition less challenging. For delegators, this model is similar to off-chain trading loan agreements, with the added benefit of additional DeFi interest earnings.

Furthermore, agreements established through OpenLaw can further protect delegators. OpenLaw is a legal agreement smart contract system supported by ConsenSys, generating agreements that are not limited to the crypto world but extend to the real world, with real-world legal enforceability.

Jordan Lazaro Gustave told ChainNews that delegators and borrowers need to reach a legal agreement based on OpenLaw. Since these individuals are within the same circle, the default risk is minimized. In addition, delegators should conduct due diligence on borrowers, similar to the cooperation model based on OTC/off-chain agreements in the past.

If there is a default or failure to repay, both parties can be held accountable through the legal agreement. In other words, if the borrower defaults and violates the agreement terms, they will face legal consequences.

As the model is gradually validated, it will transition to a trustless manner, ultimately evolving into a system where any two parties (even if they do not know each other) can reach a peer-to-peer agreement based on specific terms without permission and then proceed with credit delegation and authorization.

In the future, Aave will introduce more complex on-chain loan references in this model, including credit scoring and risk analysis, providing trust references for unfamiliar counterparties.

Impact

Once the permissionless peer-to-peer credit delegation agreement is established, it will effectively stimulate delegators and borrowers to reach agreements, creating a free market.

In this market, delegators can transfer their credit lines to others and gain customized credit risk exposure, providing various sources of liquidity globally, expanding the overall scale of DeFi funds, and positioning Aave as a global capital source to provide funding for other projects in need.

Aave, a lending platform that aggregates capital sources in the global financial market, will be able to provide funding for other projects in need, including traditional institutions beyond the crypto world.

As a missing piece in the DeFi puzzle, loan models in DeFi generally require overcollateralization to reduce risks, leading to inefficient capital utilization, a common issue in DeFi. Aave's Credit Delegation enables unsecured loans, stimulating additional loan demand and expanding the overall debt scale of DeFi.

Moreover, Aave plans to extend DeFi's influence beyond the crypto world.

Stani Kulechov stated, "Aave's medium-term goal with Credit Delegation is to enable liquidity to enter traditional financial markets, diversifying the sources of lenders' liquidity. In other words, using DeFi funds for traditional financial loans."

According to Stani Kulechov, Aave's liquidity consumers include not only cryptocurrency exchanges and market makers but also lenders, institutions, enterprises, NGOs, and governments from the traditional world.