Bank of Canada Report Highlights Borrower Risks in Aave V3 Model

• Aave V3 recorded zero bad debt as automated liquidations and overcollateralization protected lenders in volatile markets.
• Borrowers absorbed losses up to 30% due to liquidation fees and missed gains during price recoveries.
• Recursive leverage drove activity but increased risk, with liquidations concentrated in major crypto assets.

A new report from the Bank of Canada examined Aave V3 and found its lending system avoided bad debt in 2024. Using data from Jan. 27, 2023, to May 6, 2025, the study showed automated liquidations and overcollateralization prevented lender losses, even during volatile market conditions across its Ethereum-based lending markets.

According to the paper, Aave V3 reported no non-performing loans during 2024. The system required borrowers to post collateral exceeding their borrowed value. When positions breached risk thresholds, liquidations triggered automatically.

As a result, positions were often closed before collateral values dropped below outstanding debt. This structure helped contain lender losses throughout the sample period. However, the report noted that this protection relied entirely on automated mechanisms rather than traditional credit checks.

However, the same design shifted risk toward borrowers. According to the Bank of Canada, liquidation fees ranged between 5% and 10%. Combined with missed gains after price rebounds, total borrower losses reached 10% to 30% in some cases.

Moreover, liquidations occurred in concentrated waves instead of gradual adjustments. Four assets accounted for about 90% of liquidated value. These included Wrapped Ether, Wrapped Staked Ether, Wrapped Bitcoin, and Wrapped eETH.

This concentration showed how borrower risk remained tied to a narrow group of major crypto assets. Consequently, sharp price declines triggered rapid and clustered liquidations across the system.

The report also highlighted borrowing behavior across the protocol. It found that recursive leverage made up over 20% of total borrowed volume. Additionally, it accounted for 8.2% of all borrowing transactions.

This strategy involved repeatedly borrowing against collateral to increase exposure. While it boosted activity, it also increased vulnerability during market downturns. As prices fell, leveraged positions quickly approached liquidation thresholds.The findings arrive as Aave V4 launches with a new structure. According to the report, the updated design aims to separate liquidity and risk across markets while introducing more flexible borrowing conditions.