Aave founder: What is the secret of the DeFi lending market?

Author: Stani.eth

Compiled by: Ken, Chaincatcher

On-chain lending began around 2017 as a marginal experiment related to crypto assets. Today, it has evolved into a market exceeding $100 billion, primarily driven by stablecoin lending, secured mainly by crypto-native collateral such as Ethereum, Bitcoin, and their derivatives. Borrowers release liquidity through long positions, execute leveraged cycles, and engage in yield arbitrage. The key is not creativity, but validation. Behavior over the past few years indicates that automated lending based on smart contracts had genuine demand and real product-market fit long before institutions began to take notice.

The crypto market remains volatile. Building lending systems on top of the most vibrant existing assets forces on-chain lending to immediately address risk management, liquidation, and capital efficiency issues, rather than hiding them behind policies or human discretion. Without crypto-native collateral, it is impossible to see how powerful fully automated on-chain lending can be. The key lies not in cryptocurrencies as an asset class, but in the cost structure changes brought about by decentralized finance.

Why On-Chain Lending is Cheaper

On-chain lending is cheaper not because it is new technology, but because it eliminates layers of financial waste. Today, borrowers can obtain stablecoins on-chain at about 5% cost, while centralized crypto lending institutions charge interest rates of 7% to 12%, plus fees, service charges, and various additional costs. When conditions favor borrowers, choosing centralized lending is not just conservative; it is even irrational.

This cost advantage does not come from subsidies, but from capital aggregation in an open system. Permissionless markets are structurally superior to closed markets in gathering capital and pricing risk because transparency, composability, and automation drive competition. Capital flows faster, idle liquidity is penalized, and inefficiencies are exposed in real-time. Innovation spreads immediately.

When new financial primitives like Ethena's USDe or Pendle emerge, they absorb liquidity from the entire ecosystem and expand the use of existing financial primitives (like Aave) without the need for sales teams, reconciliation processes, or back-office departments. Code replaces management costs. This is not just a gradual improvement; it is a fundamentally different operating model. All advantages in cost structure will be passed on to capital allocators and, more importantly, benefit borrowers.

Every major transformation in modern history follows the same pattern. Heavy asset systems become light asset systems. Fixed costs turn into variable costs. Labor becomes software. Centralized economies of scale replace local redundancies. Excess capacity transforms into dynamic utilization rates. Transformations initially appear poor. They serve non-core users (e.g., crypto lending rather than mainstream use cases), compete on price before quality improves, and do not seem serious until they scale and existing firms cannot cope.

On-chain lending fits this pattern perfectly. Early users were primarily niche cryptocurrency holders. User experience was poor. Wallets felt unfamiliar. Stablecoins did not touch bank accounts. But none of this mattered because costs were lower, execution was faster, and access was global. As everything else improves, it becomes easier to access.

What Happens Next

During bear markets, demand decreases, yields compress, exposing a more significant dynamic. Capital in on-chain lending is always in competition. Liquidity does not stagnate due to quarterly committee decisions or balance sheet assumptions. It is constantly repriced in a transparent environment. Few financial systems are as ruthless as this.

On-chain lending does not lack capital; it lacks collateral available for lending. Most on-chain lending today simply recycles the same collateral for the same strategies. This is not a structural limitation but a temporary one.

Cryptocurrencies will continue to generate native assets, productive primitives, and on-chain economic activities, thereby expanding the coverage of lending. Ethereum is maturing into a programmable economic resource. Bitcoin is solidifying its role as a store of economic energy. Neither is the final state.

If on-chain lending is to reach billions of users, it must absorb real economic value, not just abstract financial concepts. The future will combine autonomous crypto-native assets with tokenized real-world rights and obligations, not to replicate traditional finance, but to operate it at extremely low costs. This will become a catalyst for replacing the old financial backend with decentralized finance.

Where Lending Went Wrong

Today, lending is expensive not because of capital scarcity. Capital is abundant. The clearing rate for quality capital is 5% to 7%. The clearing rate for risk capital is 8% to 12%. Borrowers still pay high-interest rates because everything surrounding capital is inefficient.

The loan issuance process has become bloated due to customer acquisition costs and lagging credit models. Binary approvals lead quality borrowers to pay excessive fees, while poor borrowers receive subsidies until they default. The service process remains manual, compliance-heavy, and slow. Incentive mechanisms at every layer are misaligned. Those who price risk rarely bear the risk. Brokers do not assume default liability. Loan originators immediately sell risk exposure. Regardless of the outcome, everyone gets paid. The flaws in the feedback mechanism are the true cost of lending.

Lending has not yet been disrupted because trust overrides user experience, regulation stifles innovation, and losses obscure inefficiencies before they explode. When lending systems collapse, the consequences are often catastrophic, reinforcing conservatism rather than progress. Thus, lending still appears to be an industrial-era product awkwardly stitched onto the digital capital market.

Breaking the Cost Structure

Unless loan issuance, risk assessment, servicing, and capital allocation are fully software-native and on-chain, borrowers will continue to pay excessive fees, and lenders will continue to rationalize these costs. The solution is not more regulation or marginal user experience improvements. It is about breaking the cost structure. Automation replaces processes. Transparency replaces discretion. Certainty replaces reconciliation. This is the disruption that decentralized finance can bring to lending.

When on-chain lending becomes significantly cheaper than traditional lending in end-to-end operations, adoption is not a question but a necessity. Aave emerged in this context, capable of serving as the foundational capital layer of a new financial backend, catering to the entire lending spectrum from fintech companies to institutional lenders to consumers.

Lending will become the most empowering financial product simply because the cost structure of decentralized finance will enable fast-moving capital to flow into the applications that need capital the most. Abundant capital will spawn numerous opportunities.