AAVE founder issues a warning: DeFi must never become the exit liquidity for Wall Street private credit

Original Author: Stani.eth

Original Compilation: Ken, ChainCatcher

Private credit is currently in a peculiar situation.

The economy is closely tied to the cost of capital. Low interest rates mean cheap borrowing costs, which theoretically should lead to higher utilization of credit instruments. Conversely, high interest rates mean expensive borrowing costs, which theoretically would reduce demand for credit.

Since the Federal Reserve began its aggressive tightening cycle in March 2022, we have been living in a high-interest-rate environment: by mid-2023, rates soared from near-zero levels to over 5%, marking the fastest rate hike cycle in forty years. By early 2026, rates remain high, with only minor reductions during this period. For many consumers and businesses that began borrowing during low or moderate interest periods and have not yet paid off their debts, this means a significant increase in the cost of capital, and this burden will continue to intensify over time.

All of this sounds quite normal. From growth to maturity, financing is almost present in every stage of a company's lifecycle. But the problem arises when the cost of capital remains high for an extended period, creating an unbearable expense for borrowers.

Companies typically borrow from financial institutions like banks or through private credit from asset management firms.

How do private credit funds operate?

Private credit funds are typically closed-end or semi-liquid investment vehicles managed by asset management companies. This structure makes sense: funds need to deploy capital into lending opportunities to generate returns. The investor base for private credit is broad, ranging from pension funds, insurance companies, family offices, to an increasing number of retail investors today.

Closed-end funds do not allow redemptions until maturity (usually 7 to 10 years). Semi-liquid funds offer quarterly redemption windows with limited amounts. Publicly traded Business Development Companies (BDCs) provide liquidity through daily trading on exchanges.

Essentially, private credit funds function similarly to private banks: they lend to businesses and charge interest.

What sectors does private credit fund?

Typically, private credit funds finance leveraged buyouts in private equity, provide loans to mid-sized companies that cannot access the public bond market, and finance certain asset-backed loans (such as aircraft, shipping, and consumer loans) as well as real estate credit.

Private credit funds often fill the financing gap left by banks exiting the market. This shift has been primarily driven by regulatory policies post-2008 (especially Basel III), which forced banks to withdraw from higher-risk corporate lending. Today, it is estimated that 80% to 90% of leveraged buyouts in the U.S. middle market are financed by private credit.

Who are the major players?

• Apollo ~ $460B AUM

• Blackstone ~ $330B AUM

• Ares ~ $280B AUM

• KKR ~ $220B AUM

• Carlyle ~ $190B AUM

• Blue Owl ~ $170B AUM

What is the current situation?

Recently, the private credit sector has begun to show signs of distress. The high capital costs brought about by high interest rates remain a real issue, while artificial intelligence is reshaping perceptions of many software companies financed by private credit, bringing uncertainty to the future of these borrowers.

The market has started to reprice private credit:

• VanEck BDC Income ETF: down about 15% over the past year

• Blue Owl Capital: down about 50% over the past year, with approximately 30% of the decline occurring in 2026

• Apollo, Blackstone, Ares, KKR: stock prices down about 20% due to concerns over private credit

Currently, the average trading price of BDCs is at a discount of about 20% to their net asset value (NAV), while offering yields of 10% to 11%, sending a clear signal: loan portfolios may be overvalued, default rates may be rising, or liquidity risks are accumulating. More concerning is that historically, these funds have typically traded at a premium.

Some monitored loan default metrics for certain funds have climbed as high as 9%. Blackstone's flagship private credit fund BCRED is a notable example.

BCRED recently restricted redemptions. The fund manages approximately $82 billion, and in the first quarter of 2026, redemption requests reached $3.7 billion, about 8% of NAV. Blackstone injected $400 million of its own capital to support liquidity. Technically, the fund has not been completely gated, but it is very close.

Meanwhile, BlackRock's $26 billion HPS Corporate Loan Fund (HLEND) received $1.2 billion in redemption requests, reaching the point where it had to freeze redemptions. About $580 million in redemption requests went unfulfilled.

Blue Owl's retail-focused private credit product faced $2.9 billion in redemptions in the fourth quarter of 2025, with redemption requests reaching 15% of NAV, primarily due to its exposure to risks in the software industry.

Can the market withstand defaults in private credit funds?

Despite total redemptions exceeding $7 billion (accounting for 5% to 10% of NAV) and the stock prices of publicly traded alternative asset management companies dropping by 20% to 30%, the overall private credit market remains robust at $1.8 trillion to $2 trillion. Even the largest funds range from $20 billion to $80 billion, whereas the global bond market is valued at $130 trillion, and bank assets reach $180 trillion. The default of a single fund is highly unlikely to trigger a broader market collapse or a contagion effect that amplifies the crisis. Additionally, large funds hold diversified portfolios containing hundreds of loans, and the semi-liquid or closed-end structure naturally locks in investor capital, thereby cushioning against bank-run-like risks.

I have outlined three scenarios of increasing severity:

• Scenario A: A large fund defaults (approximately $50 billion). Investors lose capital, some companies lose financing, and credit spreads widen. The financial system is likely able to absorb this shock.

• Scenario B: Multiple funds default simultaneously. The credit market freezes, highly leveraged companies can no longer refinance, triggering a chain of defaults. This could trigger a recession in the credit cycle.

• Scenario C: A collapse of private credit + leveraged loans. A broader corporate credit crisis erupts: private equity deals fail, and banks face risk exposure. This would be a true systemic crisis.

Fortunately, from a macro perspective, the scale of private credit funds remains relatively small, making it unlikely to pose systemic risk. However, the most concerning scenario is that a collapse of confidence first spreads in the private credit market (especially in areas lending to companies vulnerable to AI disruption), and then seeps into the public bond market. This contagion path is entirely plausible, as it can be argued that large corporations in the bond market are more susceptible to automation and AI disruption compared to the streamlined, high-growth companies typically funded by private credit.

What impact does this have on RWA and DeFi?

The private credit dilemma's most direct impact falls on capital allocators. Many private credit funds have already been distributed to retail investors through publicly traded BDCs, private credit ETFs, or semi-liquid funds (such as Blackstone's BCRED, Apollo's Debt Solutions BDC, and BlackRock's HPS Corporate Loan Fund).

These funds share common characteristics: quarterly (or monthly) redemption windows, with redemption limits typically capped at 5% of NAV per quarter, and target returns of 8% to 11%. Recently, some funds have also begun to freeze redemptions.

From the perspective of DeFi capital allocators, I believe the greatest risk is structural: the way private credit is packaged in DeFi is often not fully understood by many retail users before they invest. We have seen countless examples of DeFi users actively putting funds into high-yield real-world asset (RWA) strategies, only to later discover that their underlying exposures carry significant duration risk.

I believe that real-world assets (RWA) represent the biggest opportunity for DeFi in the near term. However, my biggest concern is that institutional speculators may view DeFi as a channel to offload illiquid and distressed products that Wall Street has already abandoned, effectively treating DeFi participants as exit liquidity. Since assessing RWA allocation opportunities is inherently more challenging, this risk is further amplified: because they lack the transparency or on-chain verifiability that native DeFi opportunities provide.

That said, if private credit can operate well on-chain, it could offer something that traditional finance cannot: enforceable guarantees through smart contracts. Redemption windows, withdrawal limits, collateral ratios, and allocation rules can be immutably encoded, meaning fund managers cannot arbitrarily change the terms after capital is deployed. In traditional private credit, investors have paid a heavy price on BCRED and HLEND to discover that when market conditions deteriorate, fund managers can unilaterally tighten or freeze redemption policies. In contrast, on-chain, these rules are transparent from day one and enforced by code, rather than being left to the discretion of pressured fund managers. This is precisely where RWA and DeFi can surpass traditional models in this asset class.

For RWA to succeed in DeFi, and for DeFi to achieve meaningful scale through real-world assets, the entire industry needs to thoughtfully and cautiously build opportunities that connect TradFi (traditional finance) with on-chain markets. This means establishing strong transparency standards, appropriate risk disclosures, independent verification of underlying collateral, and governance frameworks that protect on-chain participants from the disadvantages of information asymmetry. Without these safeguards, the integration of TradFi and DeFi could turn into a pure extraction rather than a value add.

DeFi should not become Wall Street's exit liquidity.