Aave Loses Over $12 Billion in TVL Following rsETH Incident

Original author: Sanqing, Foresight News

On May 26, Kelp DAO transferred the final batch of 20,373.72 rsETH to the LayerZero OFT Adapter, and Aave simultaneously announced that rsETH and all affected markets have been restored. Over 37 days, all 116,500 rsETH have been fully replenished.

This merely represents rsETH restoring its 1:1 backing—it does not mean Aave’s entire balance sheet has been wiped clean. The 30,766 ETH frozen by the Arbitrum Security Council remain held at the U.S. District Court for the Southern District of New York, with ownership still undetermined. Aave’s lost TVL also cannot return alongside rsETH.

According to DefiLlama data, on the day of the incident, April 18, Aave's TVL was $26.396 billion; on May 25, it was $14.181 billion. Over $12 billion has not returned after a month.

More challenging developments lie ahead. The U.S. District Court for the Southern District of New York will hold a hearing on June 5 regarding the ownership of the 30,766 ETH frozen by the Arbitrum Security Council. Both Aave LLC and Gerstein Harrow have submitted supplemental briefs by May 22. Although the judge amended the restraining notice on May 8 to permit fund transfers, the final ruling will be determined on June 5.

Gerstein Harrow represents families of victims of North Korean terrorism and holds an unenforced judgment of $877 million. Regardless of the outcome, this lawsuit is a reputational drain on Aave.

DeFi United was able to come together because multiple parties agreed to provide backing: Stani Kulechov contributed 5,000 ETH personally, Consensys and Joseph Lubin pledged up to 30,000 ETH, the Aave treasury allocated up to 25,000 ETH, supplemented by a credit line of up to 30,000 ETH from Mantle and support from Lido, Ether.fi, and others.

The community mobilization was unprecedented, but Aave exhausted this one-time-only card. Next time an upstream pollution event occurs, it may not be possible to assemble the same list again.

For example, after the incident, Sun Guangchen withdrew approximately $174 million (including 65,854 ETH and several stablecoins) from Aave to Spark, bringing his total deposits in Spark to over $1.3 billion. The whales have voted with their funds—the money has already been moved.

Aave has more than just V4 as its countermove, but V4 is the most crucial one.

V4 launched on the Ethereum mainnet on March 30, featuring a hub-and-spoke architecture with three initial Liquidity Hubs. Aave Labs has committed to a "security-first growth" approach, gradually increasing deposit limits. On April 8, deposits surpassed $10 million; on May 9, they exceeded $50 million; and by May 26, total deposits reached $86.13 million, with $27.77 million in active borrowing positions.

This rhythm was a responsible design choice before rsETH, but became a stress test afterward. Aave is managing $200 million in bad debt on V3 while gradually increasing the limit on V4.

More challenging, V4 must also contend with internal friction within its own governance. In February 2026, Aave Labs submitted a strategic proposal bundling product revenues, service provider incentives, the V4 growth engine, and brand legal custody, requesting representatives to vote on all four distinct risk dimensions in a single vote.

Marc Zeller, founder of the Aave Chan Initiative, publicly questioned whether it was appropriate to link large funding requests with strategic approvals. This governance dispute has intensified around the launch of V4, with each delay allowing competitors to gain further market share.

The advantage of V4 is the openness of the Spoke design, allowing anyone to build a Spoke and connect to the Liquidity Hub as a credit line if they meet the criteria. This is why Babylon Labs chose to integrate Trustless Bitcoin Vaults into V4 rather than another platform. However, the speed at which this openness is realized depends on whether the governance layer can keep pace.

Aave V3 remains a cash cow, generating over $100 million in annualized revenue, with $14.1 billion in TVL concentrated on V3. The "Aave will win" proposal positions V3 in a "stable maintenance" phase, with Stani publicly committing to no forced migrations and no deadlines.

V4 and V3 will run in parallel for at least 24 to 36 months, serving as an additive complementary layer to handle heterogeneous use cases that V3 cannot accommodate. Horizon is a separate, licensed fork of V3 specifically designed to serve RWA institutions.

Each layer competes for different growth segments. V4 targets new use cases that V3’s risk architecture cannot accommodate, and after rsETH, it has an additional mission: to provide a reason for funds already migrated to Morpho and Spark to return to Aave. Horizon targets RWA traffic from traditional finance, completely separate from the pools of V3 and V4.

Horizon Market launched in August 2025 as a permissioned V3 instance deployed by Aave, specifically designed to allow institutions to use tokenized government bonds, corporate bonds, and money market funds as collateral to borrow stablecoins such as USDC, GHO, and RLUSD.

Net deposits have exceeded $500 million as of May 26, with a target to surpass $1 billion by the end of 2026. Partners include BlackRock, Franklin Templeton, Circle, Ripple, and VanEck.

This approach diverges from Morpho’s vault management model. Morpho curates vaults through third-party platforms like Steakhouse and Gauntlet to capture lending demand from retail institutions such as Coinbase, while Aave directly connects with traditional financial asset managers via Horizon to access RWA.

The two paths diverge in how institutional clients are characterized. Morpho serves fintech companies that use on-chain lending as a tool, while Aave serves asset managers that treat on-chain as an issuance platform.

The fund migration following the rsETH incident primarily affects Category One clients. Category Two clients face higher migration costs and respond more slowly. Aave’s accumulated compliance framework, KYC processes, and asset admission audits on Horizon cannot be replicated by Morpho in the short term after the incident.

This is the only growth line for Aave that was not directly impacted by the rsETH event, but its growth depends on the pace at which traditional finance accesses DeFi.

Aave remains the largest protocol in the lending market, with $14.1 billion in TVL—nearly double that of Morpho—its years of accumulated deployment depth are unmatched in the short term.

But the liabilities from rsETH do not appear on the balance sheet; they reside in the column for institutional preference toward lending protocols. Spark’s TVL rose from $3.727 billion to $5.3 billion in one month, and Morpho has been gradually recovering toward its pre-incident levels since hitting a low on April 21—these figures will not automatically flow back simply because Aave’s market recovers.

The speed at which V4 delivers in heterogeneous scenarios, combined with Horizon’s progress on institutional RWA, will determine whether Aave can reclaim its lost market share. But the former is stalled by governance inefficiencies, and the latter is held back by traditional finance’s own pace of integration—both of which Aave can only wait for.

DeFi United is not a permanent institution; it is a one-time gathering.