Aave V4: From Fragmented Markets to Modular Liquidity

Written by: Tia, Techub News

In the DeFi lending space, Aave has long been a benchmark for innovation and industry standards. As user numbers and asset varieties grow, Aave V3 has gradually revealed issues such as liquidity fragmentation, risk management, and relatively coarse liquidation mechanisms. To address these challenges, Aave V4 has undergone a systematic upgrade: liquidity organization has been redesigned into a unified Hub and modular Spoke architecture, enabling multi-asset and multi-strategy liquidity sharing while maintaining risk isolation; the accounting system has been upgraded to an ERC-4626-style share model, making the overall liquidity status clear and controllable; the liquidation mechanism has shifted from a fixed ratio mode to a dynamic, health factor-centric approach with minimal necessary liquidation logic. Overall, V4 is not merely parameter optimization but a co-evolution of architecture and mechanisms, transforming Aave from a multi-market fragmented lending protocol into a more scalable, capital-efficient, and risk-controllable modular infrastructure.

From “Market”-Centered V3 to Liquidity Fragmentation Constraints

In Aave V3, the protocol adopts a “market”-centered deployment approach. On different networks, or even within the same network, Aave divides into multiple independent markets, such as Core and Prime on Ethereum mainnet. Each market has its own independent liquidity pools, supported asset combinations, and risk parameters, forming distinct risk profiles.

When users supply assets to Aave V3, they are explicitly depositing assets into a specific market, not into a global shared pool. This means assets supplied to the Ethereum Core market can only be used by borrowers within that market and cannot be accessed by Prime or other network users.

This design has clear advantages in risk isolation—risks do not propagate between markets. However, the cost is also evident: liquidity is fragmented. Even the same asset is spread across multiple markets, making centralized management difficult, which impacts overall capital utilization, market depth, and the ability to extend new features.

Hub and Spoke: Liquidity Reorganization Logic in Aave V4

Aave V4’s response to this issue is a fundamental reconstruction of the underlying architecture, introducing a new Hub and Spoke (radial) design. This approach aims to solve the long-standing liquidity fragmentation and scalability limitations present in V3.

In V4, liquidity is no longer bound within a single market. Instead, each network introduces a unified liquidity Hub, serving as the central source of all funds. User-supplied assets are no longer deposited into a specific market but are pooled into the network’s Hub, which manages global liquidity and core accounting constraints—such as ensuring total borrowed assets do not exceed total supplied assets, and recording liquidity occupation across modules.

However, the Hub itself is not directly interacted with by users. All user-facing operations are handled via a highly modular functional layer, called Spoke in V4.

Spoke: Modular Entry Point with Localized Risk

Spokes form the front end through which users interact with the Aave V4 protocol. Each Spoke connects to the same underlying liquidity Hub but can have entirely different rules, parameters, and risk assumptions. Spokes manage local user positions, collateral structures, oracle integrations, and liquidation logic, while the Hub provides limited liquidity support in the background.

This division is key: risk is strictly confined within each Spoke, preventing systemic spread. Different asset types and borrowing behaviors no longer need to share the same risk parameters but can operate with separated risk logic under a shared liquidity pool.

As a result, many functionalities that existed in V3 but were cumbersome to implement can now be more naturally realized in V4. For example, E-Mode is no longer just a parameter set but can exist as an independent Spoke dedicated to highly correlated asset groups; isolation modes can be implemented via dedicated Spokes with clear liquidity limits set by the Hub. For RWA or more complex collateral structures, V4 allows customized Spokes with stricter access control and risk rules, without spreading complexity across the entire protocol.

Unified Liquidity Accounting: How Does V4 Calculate It?

To support the unified liquidity at the Hub level, V4 abandons the previous aToken rebase model in favor of an ERC-4626-style share system.

In Aave V4, the protocol discards the previous aToken re-basing mechanism and adopts an ERC-4626-style share accounting system. This means users no longer hold aTokens that automatically increase in quantity with interest. Instead, they hold a fixed number of shares, each representing a portion of the underlying assets that increases in value over time. In other words, interest is reflected not by an increase in token quantity but by a change in the amount of underlying assets each share can redeem, aligning more closely with traditional vault accounting logic.

This share model is tightly coupled with V4’s unified liquidity design. All supplied assets are aggregated into the on-chain liquidity Hub, which uses the share system to accurately record the global asset state. The Hub does not need to concern itself with the specific borrowing strategies or risk models of each Spoke, only managing total assets, total shares, and the limits occupied by each Spoke. This design allows multiple Spokes to share the same asset pool while maintaining clear and controllable accounting, avoiding the complexity and risk spillover that can occur with traditional aToken rebase in multi-module environments.

Continuing to use the aToken rebase would cause difficulties in synchronizing exponential interest accrual across Spokes, risk and interest spillovers, and precise control over sub-module limits. The ERC-4626 share model simplifies these calculations, enabling the Hub to safely and controllably support multiple lending strategies and risk configurations under unified liquidity. This not only improves capital efficiency but also lays a solid foundation for V4’s modularity and future expansion.

Refined Liquidation Mechanism: Moving Away from Fixed Ratios

Beyond liquidity restructuring, V4 also introduces significant adjustments to the liquidation mechanism. Unlike the previous fixed ratio-based logic, V4 implements a risk-targeted liquidation engine.

In V3 and earlier versions, once a position’s health factor fell below a safety threshold, the protocol allowed liquidators to repay a preset percentage of debt via a close factor and seize collateral accordingly. This approach was effective for protocol security but often led to over-liquidation during volatile or risky situations, with liquidation sizes exceeding what was necessary to restore safety.

V4’s new liquidation engine shifts focus from a “liquidation ratio” to a “safety target.” When a position becomes liquidatable, the system calculates the minimal amount of debt to repay and collateral to seize to restore the health factor to a safe zone. Liquidation no longer aims to maximize risk removal but seeks the minimal necessary liquidation, minimizing asset erosion while maintaining protocol safety.

This means the close factor becomes a dynamic outcome influenced by the position’s risk profile. The size of liquidation adjusts according to asset volatility, collateral structure, and risk parameters, making the liquidation process more reflective of actual risk differences among positions, and helping reduce liquidation shocks and unnecessary asset sales.

Aave’s updated liquidation mechanism resembles Fluid’s design. While Aave V4 significantly improves its liquidation logic over the previous “one-size-fits-all” approach, making it more precise and aligned with actual risk, it remains different from Fluid’s integrated borrowing and DEX liquidity depth approach. Fluid embeds lending positions directly into trading liquidity pools, allowing some risks to be absorbed within pools, often avoiding external liquidators altogether. This design offers advantages in cost and execution efficiency, but Aave, relying on external liquidators, cannot fully emulate Fluid’s integrated risk absorption.

Summary

Overall, Aave V4 is not a complete overhaul but a relatively restrained yet systematic evolution: reconstructing liquidity with Hub and Spoke architecture, localizing risk via modular Spokes, and refining the liquidation engine. Aave is transforming from a multi-market lending protocol into a modular lending infrastructure capable of supporting more complex financial structures.