Liquidity Risks in Lending Protocols: Evidence from Aave Protocol

TL;DR

This paper investigates liquidity risks in blockchain lending protocols, specifically Aave, highlighting their volatility, the impact of user behavior, and the complex effects on the on-chain lending market.

Contribution

It introduces new measurements for liquidity risks in LPs, emphasizing market concentration and user loyalty effects, with empirical analysis of Aave as a case study.

Findings

Liquidity risks in Aave are highly volatile.

Repeated borrowing by regular users can negatively impact Aave.

Liquidity in Aave influences the broader on-chain lending market.

Abstract

Lending Protocols (LPs), as blockchain-based lending systems, allow any agents to borrow and lend cryptocurrencies. However, liquidity risks could occur, especially when salient loans are initiated by a particular group of borrowers. This paper proposes measurements of liquidity risks, focusing on both available liquidity and market concentration in LPs. By using Aave as a case study, we find that liquidity risks are highly volatile and show complex effects on Aave, and liquidity in Aave may affect across on-chain lending market. Compared to new users, regular users that repeatedly borrow cryptocurrencies may negatively affect Aave protocol, implying that user loyalty is a double-edged sword for LPs.