What is Aave?
Aave is a non-custodial liquidity market protocol. It specializes in decentralized lending and borrowing.
Aave allows individuals to lend and borrow money without any middlemen or custodians such as banks or companies like Celsius that take depositors money and do essentially whatever they want with it, simply put the protocol directly connects lenders and borrowers and eliminates trust and human error from the equation.
Aave specializes in automated crypto loans which are executed via smart contracts. These loans are optimized to earn interest on deposits and gain utility with borrowed assets.
The liquidity pools on the Aave platform are significantly different from a swap or an exchange. This is because the Aave protocol is interoperable with multiple blockchains, giving it access to a multitude of additional liquidity.
The Aave Team
Aave is based as a legal entity out of Switzerland, the protocol was founded by Stani Kulechov (CEO), a law student who graduated with a Masters degree at the University of Helsinki. With an interest in blockchain and fintech, Stani dedicated most of his free time to Ethereum and began exploring ways to expand its network with the goal of ultimately impacting the traditional financial system.
Another team member worthy of note is Ben Lee, who is a specialist in product & design. Ben has 10+ years experience in this field, with his prior position before joining Aave being VP of Product Design at Postmates.
Venture Capital Funding
Aave hosted a total of 9 funding rounds to amass $49 million from investors. These funds were dedicated to the Initial Coin Offering, a Seed round, a Venture round, and Aave’s secondary market. Some of these investors include Genesis One Capital, Blockchain.com Ventures, Standard Crypto, Framework Ventures, ParaFi Capital, and now-bankrupt Three Arrows Capital. Out of the 19 investors, the majority were crypto-related venture capital firms aside from a handful of angel investors totalling no more than 5.
How The Protocol Works
Aave is a trustless protocol that utilizes automated smart contracts to execute actions. A smart contract is “A code written into a blockchain that automatically executes terms of an agreement and completes actions for all parties involved, thus removing the need for trust.
In order to maintain its trustless system the protocol requires each borrower to put up collateral in case of a liquidated position or market drop. This is called an overcollateralized loan.
The first time someone uses the platform they are required to put up an amount of collateral that is sufficiently more than the first loan, however as you build a positive reputation on the platform the amount of collateral required is reduced because the protocol is able to trust you more, much like a credit score in the real world.
For all supplied assets, corresponding aTokens are automatically minted at a 1:1 ratio. These ERC20-standard aTokens instantly begin compounding interest. This stream of interest can be paid out to any selected address even if it is unrelated to the address that supplied the original collateral.
Borrowing
Aave’s smart contracts fulfil the entire borrowing process as follows.
[Step 1] Verifies each party’s information is correct.
[2] Executes contract if information is correct or rejects if any inconsistencies are found.
[3] Calculation of the loan term.
[4] Collects the deposited collateral.
[5] Distributes the cryptocurrency being borrowed.
By creating a system of smart contracts to automate the entire protocol, Aave does NOT require a third party or human verification to fulfil any action. This removes the risk of human error and manipulation and relies on correct data cross-verified through each blockchain that’s connected to the protocol.
Aave’s initial borrow limit is set to 80% of the given collateral at current market value. However, borrow limits can change depending on a Health Factor which calculates reliability, collateral strength, and percentage of ROI.
Two kinds of algorithmic rates are offered on Aave:
- Stable Rates – This is a short term fixed rate that can be re-balanced in the long term if the borrow rate goes below 25% APY and the utilization rate reaches over 95% APY.
- Variable Rates – The variable rate is constantly changing as it is subject to market conditions and on-hand liquidity. This is the “More risk more reward” option, and is best suited for experienced traders and those who are constantly following the crypto market.
To switch between rates, simply go to the dashboard and select the ‘APR Type’ button.
Lending
When it comes to lending, Aave attracts lenders by offering interest paid out through aTokens. The interest funds are sourced from the borrowers and are included in the smart contract overview.
Assets from lenders are added to the liquidity pools, which are made up of numerous DeFi platforms and therefore offer a huge variety of liquidity and borrowing options – far less difficult than matching a lender and a borrower with the same agreed amount.
How Flash Loans Work
Aave also allows Flash Loans which are uncollateralized and quick. These loans are executed within a single Ethereum transaction, usually within the parameters of another loan. This is because transactions on Ethereum are voided and reverted to their original state if the conditions of the loan are not met. If the transaction is accepted, it is then added to Ethereum’s permanent ledger and cannot be changed.
Flash Loans occur in 3 simple steps:
[1] Crypto is borrowed from Aave.
[2] The loan requests are executed over the course of an Ethereum transaction.
[3] The borrowed amount is returned along with a loan service fee of 0.09%.
Flash Loans are quite technical at the moment and only developers or users with intricate coding capabilities are able to access the system as of right now. However, expectations for developers to simplify this in the near future are very likely.
Inside the parameters of Flash Loans, developers have already been trading debt as well as collateral within the same loan transaction.
Use cases for Flash Loans include:
- Asset protection – If a borrowed cryptocurrency is in danger of crashing, a Flash Loan can quickly be executed and the borrowed crypto can be swapped for a stablecoin. In this way, there is no headache with having to end a loan at a bad time or worry about being liquidated while keeping the loan active.
- Better Options – If a better exchange rate / interest rate is found on another cryptocurrency, then trading it for that cryptocurrency will save capital, and could simply be swapped back when returning the original asset.
Protocol Stats
Right now, $7.91 billion in liquidity is locked on the Aave Protocol.
Aave community treasury comes to a total of $127.55 million, which is made up of:
- AAVE 74.4%
- DAI 7.7%
- USDC 7.6%
- (Other) 5.2%
- USDT 5.1%
Aave’s Ecosystem Reserve holds an additonal $94.94 million, and it’s Treasury Collectors provides another $32.59 million in liquidity.