A staff paper published by the Bank of Canada has found that Aave V3, a decentralized lending protocol operating on the Ethereum blockchain, reported zero non-performing loans in 2024. The study drew on transaction-level data spanning from January 27, 2023, to May 6, 2025, and examined how the platform’s automated risk mechanisms performed across that period. Researchers found that borrower positions were typically liquidated before collateral values dropped below outstanding debt, effectively shielding lenders from unrecovered losses.
Aave V3’s lending model requires borrowers to post collateral exceeding the value of what they borrow, and automated systems liquidate positions once they breach defined risk thresholds. The paper notes this approach replaces traditional credit underwriting with algorithmic controls. While the design proved effective at preventing bad debt, researchers identified a significant tradeoff: the system transferred risk to borrowers and reduced overall capital efficiency compared with conventional lending frameworks.
The study also found that borrowing activity on the platform was not limited to users seeking straightforward liquidity. Recursive leverage — a strategy involving repeated borrowing against collateral, redeployment of those borrowed assets as new collateral, and further borrowing to amplify exposure — accounted for more than 20% of total borrowed volume and 8.2% of all borrowing transactions during the sample period. The paper noted this behavior made affected borrowers considerably more vulnerable during periods of market stress.
Liquidations on Aave V3 did not occur evenly across assets or time. According to the paper, they tended to cluster in concentrated waves, with four assets accounting for 90% of total liquidated value. Those assets were Wrapped Ether (WETH), Wrapped Staked Ether (wstETH), Wrapped Bitcoin (WBTC), and Wrapped eETH (weETH). The concentration of liquidation activity around a small number of assets highlights the degree to which systemic stress can be tied to specific collateral types.
The financial impact on borrowers caught in major liquidation events could be substantial, the paper estimated. Liquidation fees alone typically ranged from 5% to 10% of the liquidated value. When factoring in missed gains from subsequent price recoveries, combined borrower losses reached approximately 10% to 30% in some instances, according to the study’s findings.
The paper concluded that while Aave V3’s structural design successfully prevented unrecovered bad debt within the sample, it achieved this outcome by exposing borrowers to abrupt and potentially large losses whenever collateral prices declined sharply. The findings raise broader questions about how risk is distributed within decentralized finance protocols and whether automated liquidation mechanisms adequately account for borrower outcomes. Aave did not respond to a request for comment before the time of publication.
Originally reported by CoinTelegraph.
