What is Aave?
Aave is a decentralized, open source liquidity protocol that lets users borrow, lend or earn interest on cryptocurrency assets without a middleman. It runs on the Ethereum blockchain.
AAVE is the native cryptocurrency for Aave, it is ERC-20 compatible. AAVE token-holders receive a transaction fee discount on the Aave platform as well as other benefits.
Liquidity providers can receive aTokens, which are created and burned based on supply and withdrawal of assets in the Aave market. The value of aTokens is pegged to the value of the supplied asset at a ratio of 1:1.
Aave software supports the creation of lending pools that allows users to borrow or lend 17 different cryptocurrencies – these include MAANA, BAT and ETH.
As with other decentralized lending protocols, Aave users have to provide collateral before borrowing. Users are able to post collateral in one cryptocurrency and borrow the same amount in another cryptocurrency. For example, you could provide collateral in DAI and borrow ETH.
Aave Pro was recently introduced – the feature allows institutions to lend, borrow and earn interest on Bitcoin, Ethereum, stablecoins and Aave.
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How does Aave work?
Aave uses an algorithm to obtain loans from a pool, as opposed to matching a borrower directly with a lender. Users can borrow a different cryptocurrency than the one deposited for collateral. This structure is known as “pool-to-peer lending” instead of “peer-to-peer lending.”
Interest on the loan is based on the utilization rate of assets that are in the pool.
For example, if very few of the assets in the pool are in use, the interest rate would be lower. This encourages more people to borrow. If a lot of the assets in the pool are used, the interest rate is higher. This encourages users that provide liquidity to deposit more capital into the pool.
Aave loans are over-collateralized, which means you need to post more collateral than the amount you want to borrow.
Aave uses aTokens to represent collateral deposited in a lending smart contract – lenders can earn interest on aTokens.
Aave includes a liquidation process that occurs “when a borrower’s health factor goes below 1 due to their collateral value not properly covering their loan/debt value. This might happen when the collateral decreases in value or the borrowed debt increases in value against each other,” the Aave website explains.
When a liquidation occurs, up to 50 per cent of a borrower’s debt is repaid and that value plus the liquidation fee is taken from the collateral available. After a liquidation, the amount liquidated from the debt is repaid.
The liquidation penalty depends on the asset used as collateral. The Aave website includes a listing of every asset’s liquidation fee.
Users can avoid liquidation by depositing more collateral assets or repaying part of their loan.
Aave is also a pioneer in offering flash loans, which are short-term and last for the span of one Ethereum block.
Flash loans are funded by unused liquidity in pools, they allow users to borrow a large amount of cryptocurrency without having to post collateral. The amount borrowed has to be repaid within the same transaction.
The Aave website explains “flash loans allow you to borrow any available amount of assets without putting up any collateral, as long as the liquidity is returned to the protocol within one block transaction.”
What is the history of Aave?
Aave got its start in 2017 under a different name, ETHlend. Stani Kulechov and a team of developers created ETHLend as a way for users to lend and borrow cryptocurrencies with each other.
The ETHLend initial coin offering in 2017 raised $600,000 worth of ETH, which was used to create one billion LEND tokens.
ETHlend struggled with a lack of liquidity and issues matching loan requests with offers to lend. The developer team worked on a revamp in 2018 and 2019 and Aave was released in 2020.
Aave saw much growth and success in its initial year. The AAVE token was the best performing DeFi asset of 2020.
Aave is similar to ETHlend in many ways, they both enable users to borrow or lend cryptocurrency.
The key difference is that Aave funds loans through a liquidity pool, as opposed to individually matching lenders and borrowers like ETHlend.
Version two (v2) of Aave was launched in December 2020 and made improvements to the platform.
In March 2022, Aave released version three (v3) which includes a portal feature that allows Aave to operate across all blockchains.
What are some advantages of Aave?
- Aave makes financial services more accessible. Anyone who has internet access can use its services including benefitting from a high yield savings account for cryptocurrency
- It is one of the world’s most popular DeFi protocols
- Aave allows users to access loans without a credit approval, instead collateral guarantees the security of the loan
- Stable rate loans can act as a fixed rate loan in the short term, but can also be rebalanced to respond to market changes
What are some disadvantages of Aave?
- There is the risk of liquidations. Aave has to carefully manage debt to ensure users can receive loans. The pool contains AAVE tokens deposited by users. The system will liquidate AAVE tokens if it needs capital injections.
- Aave is overcollateralized. That means users are required to commit large amounts of capital to obtain loans, which may pose a challenge for some people
Aave allows users to borrow, lend or earn interest on cryptocurrency assets. It is based on a pool-to-peer lending structure.
It’s important to understand that Aave loans are over-collateralized, meaning users are required to post more collateral than the amount they want to borrow.
The platform started life as Ethland, but has seen significantly more success since its rebrand and relaunch as Aave in 2020. It is now one of the world’s most popular DeFi protocols.
Upgraded versions of Aave were released in 2020 and 2022 making additional improvements and adding new features that experts say position the protocol well for continued growth and success.