Worked Example: Analyzing Aave with the 7-Layer Framework

What you'll learn

• Why a Worked Example Matters
• Layers 1-2: Problem/Solution and Team/Execution
• Layers 3-4: Technology and Tokenomics
• Layers 5-6: Competition and Community
• Layer 7: Risk Assessment and Specific Tools
• For Deeper Reading

Key terms

7-Layer Framework Worked Example

Application of the due diligence framework to Aave with current 2025-2026 numbers, demonstrating how each layer of the framework is evaluated in practice.

Aave V3

Current production version of Aave, launched March 2022. Introduced isolation mode, efficiency mode, and cross-chain Portal. Multi-network deployment across Ethereum, Arbitrum, Optimism, Base, Polygon, and many others.

Aave Safety Module

Mechanism where AAVE token holders stake to backstop protocol bad debt, earning rewards in exchange for slashing risk. Currently holds ~$400M+ in staked AAVE.

Compound Finance

Original algorithmic money market launched September 2018. Smaller TVL than Aave today (~$2-4B vs Aave $20B+) but cleaner codebase. Pioneered the cToken and COMP governance models that triggered DeFi summer 2020.

Morpho

Peer-to-peer matching layer optimizing rates on top of Aave/Compound. ~$2-4B TVL; growing rapidly with Morpho Blue. A complement to and competitor for Aave.

Spark Protocol

Aave V3 fork operating as a subDAO of Sky/MakerDAO with native USDS integration. ~$1-2B TVL; smaller and more focused than Aave.

Aave Governance Forum

governance.aave.com is the canonical Aave debate venue. One of the most-active DeFi governance forums. Reading recent AIPs is the fastest way to assess governance health.

AIP (Aave Improvement Proposal)

Aave's formal governance proposal mechanism. Submitted on the forum, debated, then voted via Snapshot or on-chain. Determines parameter changes, asset listings, treasury actions, and protocol upgrades.

Aave V3 Audit Trail

Audits by Trail of Bits, OpenZeppelin, Certora, Sigma Prime, and others. Archived at github.com/aave/aave-v3-core/tree/main/audits. Multi-firm audits before each major release are best practice.

Aave Concentration Risk

Aave's primary markets are concentrated in stablecoins (USDC, USDT) and ETH-related assets (ETH, wstETH). Stablecoin depegs or major LST failures create severe protocol stress.

Aave Bad Debt

Loans that cannot be liquidated profitably (e.g., when collateral value drops below loan value during illiquidity). Backstopped by the Safety Module up to its size; bad debt has historically remained well under 0.1% of deposits.

Composability Risk

Risk that a problem at one DeFi protocol cascades through integrated protocols. The April 2026 Kelp hack ($6B drained) hit Aave's TVL hard despite Aave itself not being directly exploited, illustrating composability risk in practice.