A recent analysis by the Bank of Canada highlights the performance of Aave V3, which recorded no non-performing loans in 2024, indicating that its structure effectively mitigated lender losses. The study, utilizing data from January 27, 2023, to May 6, 2025, revealed that automated liquidations and overcollateralization played crucial roles in maintaining the integrity of its Ethereum lending market.
However, the report also points out that this model comes with drawbacks, as it shifts risk onto borrowers, leading to decreased capital efficiency compared to conventional lending practices. Borrowers are required to post more collateral than the amount they wish to borrow, with liquidations triggered when they surpass defined risk limits.
Additionally, the paper found that over 20% of the total borrowed volume was driven by recursive leverage, which involves repeatedly borrowing against collateral. This practice raised concerns about borrower exposure during market downturns, as liquidations often happened in concentrated waves involving four assets: Wrapped Ether (WETH), Wrapped Staked Ether (wstETH), Wrapped Bitcoin (WBTC), and Wrapped eETH (weETH). The study warned that liquidation fees and missed gains during price recoveries could lead to borrower losses of 10% to 30% during significant liquidation events.