Aave borrowers paid up to 36% APR during freeze

Aave borrowers in frozen reserves continued to pay interest at rates of up to 36% annual percentage rate (APR) while the protocol blocked fresh deposits. The restrictions, implemented during the Binance hack, prevented users from supplying additional collateral to protect existing loans, creating a scenario where debt serviced costs remained high despite the inability to adjust loan positions.

Deposit Restrictions And Interest Burden

The freeze on deposits in specific Aave reserves meant that borrowers could not increase their collateral ratios. In normal market conditions, a borrower facing a high interest rate or a volatile asset price might supply extra collateral to ensure their loan remains healthy and avoid liquidation. During the period of the freeze, this mechanism was unavailable. Borrowers were locked into their current collateral positions while interest accrued on their outstanding debt.

According to the data, the maximum APR faced by borrowers in these affected reserves reached 36%. This high cost of borrowing persisted even as the ability to mitigate risk through additional collateral was removed. The restrictions effectively halted new borrowing in the affected reserves, limiting the amount of liquidity available for new loans while existing loans continued to accrue interest.

Supplier Withdrawals And Market Impact

While new deposits were blocked, suppliers in the frozen reserves retained the ability to request their funds back. This asymmetry in access created a dynamic where the supply of assets in the reserve could decrease over time. Suppliers were able to withdraw their tokens, provided that enough tokens were available in the reserve to fulfill the requests.

As suppliers withdrew assets, the total liquidity in the reserve decreased. With new borrowing blocked and deposits frozen, the reduction in available supply could further impact the economics of the reserve. Specifically, withdrawals by suppliers could make borrowing more expensive for any remaining or new positions, although new borrowing was technically blocked in those specific reserves. The interplay between fixed high interest rates for existing borrowers and the potential for reduced liquidity due to supplier withdrawals defined the market conditions during the freeze.

The situation highlighted the operational mechanics of Aave’s risk management during a security incident. By freezing deposits, the protocol aimed to secure the reserves, but this action had immediate consequences for the cost of capital for existing borrowers. The inability to add collateral meant that borrowers had less flexibility to manage their loan-to-value ratios, relying instead on the stability of their existing collateral while paying elevated interest rates.