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What is Aave? Introducing Next-Gen DeFi Lending Protocol

Deen Newman

Deen Newman

September 4, 2022

8 min read

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Founded in 2017, Aave is a Switzerland-based DeFi lending protocol. The platform is committed to providing community-led decentralized financial services. By combining Ethereum utility and complex decentralized technology, Aave has skyrocketed in popularity.

What is Aave crypto?

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Being a vastly attractive sector of blockchain technology, DeFi (Decentralized Finance) aims to dethrone regular financial institutions by actively supporting crypto development. Aave is a project designed to let users lend and borrow digital crypto assets via its platform.

Aave consists of smart contracts that successfully handle all matters related to security, trust, open-sourceness, etc. Aave works in a user-friendly way: via utilizing protocols, users are able to deposit assets and earn interest in return; whereas other participants have an option to pay interest fees in order to borrow cryptocurrency from the pool of deposited funds.

As mentioned above, the DeFi protocol runs on ETH, meaning that Aave is compatible with EVM tokens. At the time of writing, the platform has roughly $6,300,000,000 liquidity locked within the network’s multiple services.

How does Aave work?

Originally called ETHLend, Aave was released through an initial coin offering and became an instant success. After its rebranding and completely revamping the concept of a DeFi lending protocol, Aave was initiated as an independent project in 2020.

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The platform’s innovative technology implies that loans are taken out of a pool of assets instead of a stand-alone lender. The interest rate of a specific pool largely depends on the so-called “utilization rate”, meaning the more deposits are made in a pool, the higher its interest rate. This also boosts liquidity providers’ engagement in low-interest pools.

Through Aave, users can take out loans, borrow against the collateral across Aave’s multiple networks, and participate in the platform’s governing decisions.

What are flash loans?

Based on the ETH network design, a flash loan is a popular feature on Aave. Flash loans are rapidly executed (there is no need to supply collateral) and repaid within the same ETH transaction (+ a small fee). This is usually done in a matter of 13 seconds. If the borrower doesn’t follow the exact requirements, the transaction is therefore canceled. In order to take a flash loan, developers have to build specific smart contracts with the help of the instructions given here.

As the flash loan is reversed, it is also removed from the blockchain history. As the Aave team is saying, flash loans do not have an analogy in the real world, therefore it requires some basic understanding. It is also required that developers have strong programming skills before taking out a flash loan.

What is an AAVE token?

Being a native and utility token for the platform, $AAVE is among the most popular DeFi tokens on the market. Initially known as $LEND, the token was sold via an ICO of $16 million to help fund the startup. As of October 2020, the assets were turned into $AAVE - an ERC-20 token. $AAVE can be earned through buying (click here to check the list of markets) or staking, which is carried out within the platform’s “Safety Module”. In the case of token deficiency (a shortfall event), those affected by it can get up to 30% of the safety module paid back.

It is worth mentioning that the DeFi lending protocol also supplies aTokens, which are issued to lenders in order to collect interest on deposits. This is a different type of token, not to be confused with the native asset of the platform.

Benefits

Decentralized

One of the key advantages of using Aave is its decentralized approach to the digital finance sector. By keeping the platform open-source, Aave guarantees top-notch security and privacy for its users.

Non-custodial

Aave is a non-custodial protocol, which implies that the platform does not hold crypto assets directly on its network, therefore allowing users to keep ownership of their funds. This minimizes the possibility of hacker attacks as there are no wallets with stored assets to steal.

Flash loans

Aave was the first platform to introduce flash loans, therefore shifting the way developers approach DeFi-based lending protocols. Now, these almost-instant transactions are widely utilized for yield farming and arbitrage opportunities.

Interest rate flexibility

Another significant feature offered by Aave is the ability to select and switch their preferred rate options in liquidity pools. This is largely due to the extreme volatility of the crypto market. Now users can choose between stable and variable interest rates depending on their goals.

Broad selection of assets

Aave markets include big players such as Ethereum, Avalanche, Polygon, Arbitrum, Fantom, Optimism, etc. making the platform highly attractive for users with various goals. There are also stablecoins lending pools available.

Drawbacks and risks

Now that we have covered some of the key benefits regarding Aave, let’s mention a few of the potential drawbacks associated with the platform.

Largely reliant on Ethereum

While ETH is the second-largest cryptocurrency in the world, its popularity has certainly affected the blockchain, e.g. driving Ethereum gas fees, slowing down workload, etc. Gas is used to power transactions within the Ethereum network, which can also cause blockchain congestion - not an ideal situation for platforms built by using the supreme Ethereum technology.

Over-collateralization necessary to take out a loan

Due to over-collateralization, users are obliged to post more collateral to cover for a potential shortfall event. While Aave is not the only lending protocol to require over-collateralization, this is still a major con to pay attention to. In Aave V3, borrowers are not reliant on the over-collateralization (learn more here).

Not user-friendly

Aave offers an array of community-focused services and features; however, the platform itself is not as user-friendly as it could be. For instance, in order to take a flash loan, developers are required to write specific smart contracts, and while for many this is not a difficult task, others may experience trouble properly utilizing Aave’s many functionalities.

Frequently Asked Questions

How to use Aave correctly

If you want to use the Aave DeFi lending protocol, you need to make a deposit into an Aave’s supported wallet. Click on the deposit tab and connect your wallet to the platform. Now you can borrow, swap, stake and vote by using your tokens.

Is staking on Aave safe?

Staking on Aave is considered rather safe, thanks to its Safety Module feature. Besides, the staking process is beginner-friendly and transparent. We advise you to do your own research before committing to any kind of activity involving money.

How does Aave lending work?

Being a DeFi lending protocol, Aave has removed intermediaries from financial processes, such as asset trading, taking out loans, etc. Hence why when users lend, they earn interest. When they borrow, they have to pay interest. However, Aave requires over-collateralization. Therefore, if you want to take out a $100 loan, you would have to put up more than the initial amount you are planning to borrow. In the event of a shortfall event, the protocol can take your collateral to cover the costs of the loan.

What blockchains use Aave?

Aave runs on the Ethereum network. Currently, the lending protocol offers pools for both EVM-based assets and stablecoins, such as Tether, DAI, USD Coin, etc. The platform also works with Polygon, Harmony, Optimism, Avalanche, Arbitrum, and others.

With the upcoming Ethereum transition from Proof-of-Work to Proof-of-Stake, Aave is also planning to adjust to new changes.

The platform is expected to encourage commitment to Ethereum mainnet over ETH forks.

Closing thoughts

Aave is a great community-focused and fully decentralized lending platform. This next-gen protocol has already drastically improved the DeFi sector as a whole by launching cutting-edge technological solutions. Utilized by major platforms and blockchain professionals, Aave has become the driving force for innovations in digital finance.

Deen Newman

Deen Newman

September 4, 2022

8 min read

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