This is how Aave and Uniswap are preparing to revolutionize DeFi lending with GHO and LP tokens.

Aave and Uniswap are looking to revolutionize DeFi lending with a proposal to allow LP tokens as collateral for the GHO stablecoin.

In the dynamic world of decentralized finance (DeFi), two giants, Aave and Uniswap, are poised to redefine how users access digital loans. Their latest offering integrates Uniswap V4 liquidity tokens (LPs), assets representing participation in token swap pools, as collateral for borrowing in GHO, Aave's native stablecoin. 

According to the proposal, this innovation not only expands collateral options in DeFi, but also creates a collaborative economic model between both platforms, where the generated revenue is distributed among their governing communities (DAOs). 

With technical implementation already well underway and a $3,3 million funding request from the Uniswap Foundation, the initiative promises to increase capital efficiency and attract new users. Galaxy Digital analyst Zack Pokorny highlighted its potential to consolidate both platforms as industry leaders, although he also warned of technical and market risks.

Uniswap V4 LP Tokens: The New Frontier of Collateral in DeFi Lending

Uniswap V4 LP tokens have historically been static assets, generating fees but unable to be used for other financial purposes. Therefore, Aave's proposal seeks to change this paradigm by allowing these tokens to serve as collateral for loans on GHO. Technically, each LP token is an ERC-20 asset that reflects a user's contribution to a liquidity pool. Uniswap V4 optimizes its functionality with adjustments to reduce transaction costs and improve security against volatility.

For users, this means accessing immediate liquidity without selling their positions on Uniswap. For example, a liquidity provider on the ETH/USDC pair could use their LP tokens as collateral on Aave, earn GHO, and reinvest it in other opportunities while keeping their fee earnings. 

Aave, for its part, will implement specialized oracles and safety margins to prevent premature liquidations, a critical risk given that the value of LP tokens fluctuates with the prices of assets in the pool. According to the proposal, the system inherits the Aave V4 risk framework, tested in markets with over $6.400 billion in deposits.

A revenue-sharing model between DAOs

The collaboration, according to the proposal Aave's new revenue-sharing model includes an unprecedented revenue-sharing scheme between Aave and Uniswap. Initially, 50% of the interest generated by GHO lending will go to the Uniswap DAO and the other 50% to the Aave DAO. However, once certain milestones are reached, such as a specific lending volume, the distribution will shift to 80% Aave and 20% Uniswap. This model seeks to align incentives and foster mutual growth, as Uniswap would earn recurring revenue from its infrastructure while Aave expands its product offering.

However, the agreement is not without controversy. Some members of the Uniswap community question whether the proposal consumes a significant portion of the foundation's grant fund, such as the $3,3 million requested for the proposal's development, and also prioritizes Aave over other projects that could independently integrate LP tokens. However, Aave Labs defends the request, arguing that technical development is 90% complete, requiring only external audits and final testing.

Potential risks of Aave's proposal

GHO, Aave's stablecoin launched in 2022, is a key element in this proposal. Unlike other stablecoins, GHO is issued in a decentralized manner: users create it by depositing collateral into Aave, with interest rates controlled by its DAO. By integrating LP tokens as collateral, GHO could expand its adoption and utility, competing with options like DAI or USDC.

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However, the risks are significant. The volatility of Uniswap pools could lead to massive liquidations if asset prices drop sharply. Aave has proposed mechanisms such as dynamic safety margins and real-time price oracles to mitigate this risk. Furthermore, GHO's stability will depend on its underlying collateral, in this case LP tokens, maintaining its value, which could be a challenge in bear markets. 

In this regard, Zack Pokorny warned that, although the model insulates Aave's liquidity providers from these risks, GHO holders could face temporary pullbacks from their dollar peg if the collateral depreciates.

In short, the collaboration between Aave and Uniswap marks a milestone in the evolution of DeFi, transforming LP tokens into multifunctional financial tools and establishing a revenue-sharing model between protocols. While the proposal offers opportunities to optimize capital and strengthen both communities, its success will depend on flawless technical execution and managing risks such as volatility and GHO governance. 

Despite the challenges, Zack Pokorny noted that this partnership could lay the groundwork for a more interconnected DeFi ecosystem, where synergies between protocols drive bold and sustainable innovations.

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