Aave V3 “Zero Bad Debt” Study: On-Chain Liquidations Shift Risk to Borrowers
A Bank of Canada staff report says Aave V3 on Ethereum achieved “zero bad debt” in 2024. Using transaction-level data from Jan 27, 2023 to May 6, 2025, the study argues that over-collateralization and automatic on-chain liquidations helped prevent lender losses by closing positions before collateral value fell below outstanding debt.
For traders, the key nuance is risk shifting rather than eliminating it. Aave V3 replaces traditional credit checks with automated risk controls, so liquidation thresholds are enforced by protocol logic. Liquidations can cluster in market drawdowns, and the report estimates borrower hit rates of about 5%–10% from liquidation fees, potentially rising to 10%–30% when missed upside after price rebounds is included.
The report also quantifies stress points. Recursive leverage makes up about 20% of total borrowed volume and 8.2% of borrowing transactions. Liquidation activity appears in “waves,” with four assets—WETH, wstETH, WBTC, and weETH—accounting for roughly 90% of total liquidated value. While the “zero bad debt” narrative may support DeFi lending risk sentiment, AAVE traders still face broader technical caution per the article’s market snapshot.
Neutral
The report’s “zero bad debt” finding is broadly supportive for lender protection and can improve sentiment around DeFi lending risk controls. However, it explicitly reframes the outcome as protocol-driven risk shifting to borrowers during downturns. Because liquidation clustering is expected in drawdowns, the near-term effect on AAVE (price and sentiment) is more likely to be mixed: sentiment may improve, but volatility risk tied to WETH/wstETH/WBTC/weETH collateral spikes remains. Therefore the net price impact on AAVE is likely neutral rather than decisively bullish.