What Remains After the Lending Market Disappears?

Aave withdraws from six chains, causing a chain reaction due to the collapse of credit infrastructure.

Written by: Vaidik Mandloi

Compiled by: Chopper, Foresight News

Last week, Aave announced it would shut down lending markets on six blockchains. Each of these chains generated less than $5,000 in revenue per quarter. Given Aave's typical revenue share of 13 cents for every $1 in interest, the earnings from Mentis and Aptos would barely cover a dinner. In contrast, Aave's deployment on Ethereum generated $142 million last year; meanwhile, it expanded to new chains like Linea, with the V4 version's deposits exceeding $300 million.

This article will delve into what these public chains will face after Aave's withdrawal and whether any projects will take Aave's place. If no one steps in, these public chains may permanently lose their credit functions.

The Collapse of Chain Reactions

What happens when a leading lending protocol withdraws from a public chain? Let's review past cases.

The first case is Harmony Protocol. In June 2022, its core cross-chain bridge, Horizon, was attacked, resulting in a loss of about $100 million. As the largest lending protocol on that chain, Aave froze all on-chain reserve assets. Later that year, the community proposed a rescue plan, but it was rejected by 99% of Aave token holders. Today, this public chain has vanished, primarily due to a complete loss of lending liquidity.

You might wonder: why not simply fork Aave and redeploy it on Harmony? After all, the code is open-source, and deploying a lending protocol takes less than a day. While this reasoning is valid, it is often overlooked that the lending market requires ongoing maintenance, oracle support from funding sources for collateral asset pricing; it also needs sufficient DEX liquidity to ensure that collateral can be automatically sold without causing more than a 40% price slippage during liquidation.

Additionally, stablecoin issuers must recognize this public chain and support on-chain native redemptions. This means that issuers like Circle and Tether can issue tokens natively on that chain, allowing users to exchange USDC for fiat directly without cross-chain transactions. After Harmony's cross-chain bridge collapsed, all stablecoins on-chain became unpegged, oracle pricing failed, and the liquidation mechanism could not operate at all. The entire set of components supporting the lending market malfunctioned collectively. After this, no party had the commercial incentive to rebuild this system. On a public chain with no lending demand, who would still be willing to spend money to maintain oracle pricing?

Another typical case is Fantom, which also faced a cross-chain bridge hack in 2023. Before this, 78% of the chain's market value depended on this bridge. After the attack, the bridged USDC price on Fantom plummeted to about $0.22, causing a significant drop in the value of collateral and leading to insolvency.

The most thought-provoking point is that Fantom was once the third-largest DeFi public chain in the crypto industry, with real users and lending demand. Even with these fundamentals, it still failed to rebuild its credit market. For a public chain losing users, the cost of rebuilding the entire underlying infrastructure for oracles and stablecoins is always higher than the potential gains, as the core user base has long departed.

Subsequently, Fantom attempted to rebrand itself as Sonic, trying to turn the situation around solely through capital. The project launched a $190 million token airdrop, and on the first day, Aave, Silo, and Euler all completed their deployments, with Wintermute providing market-making support. However, the results were contrary to expectations, and the project faced a witch attack. Most depositors and borrowers were the same group of users: they deposited assets to earn airdrop points and then used the same assets as collateral for loans to maximize point earnings. The TVL was inflated, as the same funds were repeatedly counted through leverage cycles.

The lending demand came entirely from airdrop incentives rather than genuine economic activity on-chain requiring operational funds and leverage. For example, Ethereum users borrowing might be cyclically staking stETH or obtaining funds for trading strategies, regardless of whether the protocol offers rewards, the demand is real. But in Sonic, once the incentives are removed, there is no real lending demand. This directly led to a 98% drop in on-chain TVL after Wintermute's partnership ended, with token prices falling below one cent, and both founders resigned from the board. Subsidies and market-making partnerships can create a false appearance of a lending market, but they cannot sustain it in the long run.


Data source: DeFiLlama

Looking at the public chains from which Aave is about to withdraw, such as Soneium, Aptos, Zksync, and Scroll, their situation is worse than that of Harmony and Fantom. On-chain deposits have already plummeted by 95%, and quarterly revenue from lending operations is less than $5,000.

Harmony and Fantom at least had real user-generated native lending demand before being hacked. In contrast, these six public chains have never formed any native business demand. These public chains have an average of $250 million in financing each and have deployed the most cost-efficient lending protocols in DeFi, yet they still failed to generate real demand.


Data source: Aave governance page

Aave's exit will also trigger a chain reaction. Many people do not realize that Aave is the core pillar of financial infrastructure for these public chains. Almost all Chainlink oracle pricing on these chains is maintained by Aave, as it is the largest user. After Aave withdraws, all oracle service providers will reassess whether they should continue to maintain pricing for a public chain with no active lending market. Market makers will also stop investing in DEX on these public chains for the same reason. Even stablecoin issuers will not provide native issuance support for public chains with monthly revenues of less than $1,000. The exit of one service provider will accelerate the departure of the next, as the commercial viability of all service providers relies on the normal operation of other supporting services.

Resources will accelerate towards public chains that are operating well, have ample liquidity, and where the lending market can function normally. The exit of the infrastructure for each niche public chain will further strengthen the agglomeration effect of leading public chains, making it even weaker for the remaining niche public chains to maintain their own lending infrastructure's commercial logic.

This centralization will self-reinforce, as lending is the foundation of the entire financial system of a public chain. Without lending, most yield strategies cannot operate, as most strategies require using one type of asset as collateral to borrow another type of asset; efficient liquidity market-making is also out of the question, as concentrated liquidity positions often rely on borrowed funds. Once lending disappears, all financial applications built upon it will lose their foundation. Consequently, developers will gradually leave, on-chain activity will further decline, and no infrastructure service providers will be willing to stay.

For this reason, Aave has set a threshold for future deployments on new chains: annual revenue must reach at least $2 million. This amount is essentially the cost of maintaining oracle pricing, risk monitoring, and the entire lending infrastructure for a single public chain. This also illustrates that the past model of public chains raising hundreds of millions and quickly launching through liquidity subsidies is no longer feasible and lacks sustainability.

Not Unique to the Crypto Industry

The loss of credit infrastructure in public chains is not a phenomenon unique to the crypto sector. Any industry with high fixed costs but a small market size will encounter similar issues.

After 2008, major banks worldwide began cutting off agency banking services with some small countries. The logic is highly similar to Aave's: anti-money laundering monitoring and regulatory reporting incur fixed costs for each partnership established, and the income from some small cross-border transactions cannot cover these costs. Between 2011 and 2022, the number of effective agency banking partnerships globally decreased by 30%. The dollar clearing channels in the Pacific island nations shrank by over 60%, with some countries left with only one agency bank. The situation became so severe that the World Bank had to allocate $69 million to subsidize the remaining clearing service providers in eight Pacific countries to keep them operational.


However, there is a key difference between the crypto industry and traditional cases. In the traditional agency banking system, there are safety nets provided by the World Bank, with central banks and development agencies offering subsidies to maintain operations. But the crypto industry lacks such safety nets, which is the reality these public chains are facing. A medium-sized bank incurs compliance costs of $15-40 million annually, and the World Bank's investment of $68 million only preserves the last dollar clearing channel for eight countries. In contrast, the total cost of risk monitoring contracts for all public chains under Aave is only $5-8 million, which these six public chains cannot even afford to share.

Of course, this does not mean that DeFi lending as a whole is shrinking; on the contrary, the industry is experiencing rapid growth while becoming highly concentrated. Morpho's TVL grew from $105 million to over $8 billion in just one year; Euler expanded from $6 million to $300 million in a matter of months. Aave's V4 surpassed $300 million in deposits within just a few months of its launch, and Société Générale became the first traditional bank to integrate with a DeFi lending protocol. The credit market is thriving, but resources are concentrated in Ethereum and a couple of second-layer networks like Base and Arbitrum, rather than being dispersed across dozens of public chains.

The large number of public chains that emerged in the past was based on the assumption that the cost of deploying infrastructure is extremely low, allowing each public chain to build its own financial system. This assumption is only half correct; while the cost of launching a public chain is indeed low, running a lending infrastructure on it is very costly. Currently, the top three public chains and Ethereum account for 90% of the TVL. The remaining public chains can only compete for a tiny share, and this revenue barely covers the costs of a single set of Chainlink pricing. These public chains may eventually see a version of Aave forked with oracle deficiencies, or they may leave nothing behind.

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