Aave (LEND) Review: Decentralised Lending Platform
With the state of the world economy, many people are considering decentralized Finance (DeFi) as an alternative to traditional Finance. Indeed, DeFi has been a scorching hot topic in crypto for a while, and it's gradually gaining more adoption from individuals and institutions. Cryptocurrency lending protocols such as Compound, MakerDAO, Euler, and Aave have been the main attractions to this financial spectacle with good reason.
We first wrote about the Aave project in 2019, when it was known as ETHlend, and the native token was LEND. As you will see in this article, Aave is not "just another cryptocurrency lending platform" but is one of the undisputed world leaders in DeFi.
"Your assets, secured: Audited by the world's leading security firms, security of the Aave Protocol is the highest priority." Source: Aave
What is Aave?
Aave (pronounced "ah-veh") is an open-source liquidity protocol, a decentralized cryptocurrency lending platform. It was the first DeFi lending protocol when it launched its first main net as ETHlend in 2017 (before DeFi became a "thing").
Initially, Aave was designed to work on the Ethereum network with ERC20 tokens, also adopted by Aave for processing transactions.
Aave means "ghost" in Finnish. Hence the appearance of cartoon-like ghosts on the Aave website. Stani Kulechov founded the original company in 2017 and quickly became passionate about working with leading developers from other projects within the DeFi space.
Kulechov is hyper-focused on ensuring the platform is attractive to institutional and retail investors, inside and outside the cryptocurrency industry.
To briefly recap, ETHlend was a peer-to-peer marketplace where borrowers and lenders could negotiate terms without a third party thanks to smart contracts. The platform was moderately successful, but the Aave team decided they could improve the platform and were “ready to be serious players” in the DeFi space.
This decision led to the launch of the Aave mainnet in January 2020, introducing a completely new protocol and a few novel features that changed DeFi forever.
In March 2022, with the launch of V3, Aave introduced a feature called "Portal," enabling Aave to work smoothly across several blockchains. So, if you're using AAVE, you can join in lending and borrowing on other chains, such as Avalanche.
In January 2023, the Aave governance members gave unanimous approval for the deployment of the V3 iteration of the protocol on the Ethereum network. The V3 release introduces fresh technical capabilities and advantages, encompassing enhanced capital efficiency, expanded collateral choices, and refined gas optimization enhancements.
2023 was a busy year for Aave, after the deployment of V3 to Ethereum, they also announced the activation of GHO stablecoin in July and released a new governance model for the decentralized social media platform Lens Protocol later in the year.
How Does Aave Work?
Aave operates as a decentralized financial system online. It allows individuals to lend and borrow digital money and valuable items without a central authority. Lenders make extra money, while borrowers pay a small additional amount when they borrow.
Traditionally, when you needed a loan, you'd head to a bank or a financial institution. You would need to provide something valuable as security (like your car's title for a car loan), and in return, the bank would lend you the money. Each month, you'd pay back the money you borrowed along with interest.
In DeFi (Decentralized Finance), the lending process is different because there's no bank involved. Instead, smart contracts take charge of the process. Smart contracts may seem complicated, but they aren't. They are like computer codes that can automate tasks like selling a token if its price exceeds a certain level.
DeFi focuses on eliminating intermediaries regarding things like trading assets, making agreements for future trades, and even saving money.
On platforms like Aave, you can borrow cryptocurrency from real people (who have deposited into liquidity pools) instead of going cap in hand to the big financial institutions. Of course, you still need to offer some collateral as a guarantee, but the requirements are more flexible than traditional banking. In the DeFi world, that often means using other types of cryptocurrencies as collateral.
Like other lending protocols within the space, Aave offers overcollateralized loans, meaning that a user must lock a larger amount of collateral (in USD) than the loan. This amount depends on the asset and ranges from 50-75%.
For example, suppose you want a $500 crypto loan on Aave. You might have to provide a figure like $750 of another cryptocurrency as collateral. This arrangement acts as a safety net for the lender. So, if the value of your collateral drops and it's not enough to cover your loan, the system might sell your collateral to cover the cost.
Aave Liquidity Pools
Users can deposit their digital assets into Aave liquidity pools. These pools then become the funds for lending.
Interestingly, Aave isn't just about digital assets. They also have pools for real-world things like real estate, invoices for shipping, and payment advances. They've partnered with Centrifuge RWA to help regular businesses turn parts of their operations into digital tokens. These tokens work a bit like bonds and can earn people extra money. These real-world tokens can even be used as a promise to pay back loans.
In summary, Aave is all about making lending and borrowing in the digital world more accessible and efficient, and not just about cryptocurrencies, all while putting you in control of your financial choices! Something traditional banks appear less keen to do.
" Aave Liquidity Protocol: Earn interest, borrow assets, and build applications." Source: Aave
How Aave Liquidity Pools Work
Before Aave V3, if you needed to borrow a digital asset, you had to find someone on the platform willing to lend it to you, and you both had to agree on the terms and price.
But things changed and became more interesting since then. Instead of a peer-to-peer system, Aave created a pool-to-peer lending system. When you deposit into these liquidity pools, you receive aTokens. For example, if you deposited DAI into the pool, you would receive aDAI tokens in return.
When you hold the aTokens, you receive a share of the Aave flash loans. These are short-term fast loans, like a "payday loan." The amount you earn depends on supply and demand. For instance, if the pool is short of liquidity and really needs your tokens, you will earn more.
According to Aave documentation, flash loans are for developers because the execution requires technical knowledge. Borrowers do not have to submit collateral if the liquidity returns to the protocol within one block transaction, with fees and interest included.
"$ 7,559,679,910.73 of liquidity is locked in Aave across 5 networks and over 11 markets." Source: Aave.
Aave Flash Loans Explained
Flash loans are something that many consider to be the next generation of finance and are arguably Aave’s most famous contribution to DeFi so far. This controversial function lets users borrow large amounts of cryptocurrency with absolutely no collateral.
Given the incredibly short amount of time that the asset can be borrowed, you might be left wondering how this feature could be useful. Believe it or not, the utility of this feature has yet to be fully realized given that both it and DeFi are so early in their development.
For the time being, flash loans have 3 primary use cases: to trade the asset elsewhere to make a profit (also known as arbitrage), to refinance loans in other lending protocols or swap the collateral currently deposited on them.
Flash loans have allowed cryptocurrency traders to do a whole bunch of wacky stuff, primarily yield farm. They are the key to the now famous Compound yield farming technique within InstaDapp, a DeFi protocol aggregator.
What is more is that Aave has made the underlying code to flash loans publicly available, which opens the door to many other possibilities since virtually any other Ethereum developer can implement it on their platform. This is in fact why InstaDapp is also able to offer the feature.
Aave Interest Rate
Aave interest rate calculations are somewhat complex. It offers two interest rates: stable and variable. They are determined algorithmically based on the utilization rate of an asset pool (in other words, demand), where an increase in the utilization rate of a given pool results in an increase in interest rates for lenders and borrowers (and vice versa).
The stable interest rate is the average of the asset's last 30 days of interest rates. The interest rate history is transparent when lending or borrowing an asset on the platform. You can switch between stable and variable rates anytime (you just have to pay a small ETH gas fee).
Aave has an impressive selection of markets:
- Ethereum: The largest market on the Aave protocol.
- Optimism: A fast, secure, and simple" EVM equivalent rollup chain."
- Metis: A Layer 2, EVM-compatible scaling solution using optimistic rollup technology.
- Arbitrum: This network has the security of the Ethereum network but with faster speeds.
- AMM: "Reduced volatility from supplying assets and earn trading fees from the market."
- Aave Arc: A permissioned DeFi market for private funds, wealth managers and institutions.
- Centrifuge RWA: Bridging real-world assets like real estate, invoices, and royalties to DeFi.
- Polygon: Lower fees and quicker transactions mean using Aave on Polygon is ideal for high-volume transactions.
- Avalanche: Known for cheap, fast transactions, Avalanche offers AVAX rewards for supplying liquidity or borrowing.
AAVE Governance Tokens
Aave began migrating LEND tokens to AAVE in late 2020 at a rate of 100 LEND tokens for 1 AAVE, dropping the total supply to 18 million AAVE tokens. At the same time, Aave introduced a game studio for blockchain games, a trading desk for the management of large trades and a payment handling system.
AAVE is the governance token for the Aave protocol. One AAVE token equals one vote, so the more tokens a user holds, the more voting power they have. AAVE can also be used as collateral for borrowing. In addition, you can receive discounts and bypass borrowing fees if you directly borrow AAVE.
AAVE has a large market cap of $924,336,324 and is ranked in the top fifty tokens by CoinGecko. AAVE reached an all-time high in May 2021 at around $665. Price action currently reflects the crypto bear market and prices have been static for many months, with AAVE averaging at around $64 (August 2023)
Where to Buy AAVE Tokens
AAVE tokens are available on some of the leading, established cryptocurrency exchanges, such as the following:
Aave Community And Security
Aave Grants DAO
The Aave Grants DAO is a program led by the community for funding ideas from Aave holders. The focus is to empower a “wider network of community developers.”
Some of the leading security firms audit the Aave network: -
- Trail of Bits
Aave has a Safety Module, a safe backstop of $283,513,952 in case of protocol insolvency.
Aave also has a generous bug bounty for its community to identify potential vulnerabilities or bugs. Depending on the evaluation of the severity of the issue exposed, Aave will pay a reward of up to $250,000.
"Bug Bounty: We want the Aave protocol to be the best it can be, so we're calling on our community to help us find any bugs or vulnerabilities." Source: Aave
The Aave Community Treasury
The Aave treasury stands at $97,112,249 (August 2023) and comprises of the Aave ecosystem reserve (AAVE tokens), and in addition, treasury collectors earn a percentage of fees from the following: -
- Reserve Factor: Interest paid by borrowers.
- Instant Liquidity Fees from transactions.
- Liquidation Fees: (not yet active August 2023): Collateral liquidation bonus.
- Portal Fees: (not yet active August 2023) paid by “bridging protocols to reback assets.”
The Aave Community Treasury comprises the following assets: -
- AAVE: 75.8%
- USDC: 7.3%
- DAI: 7.2%
- USDT: 5.3%
"Governed by the community: Aave is a fully decentralized, community governed protocol with 155,881 token holders."
GHO is a fully backed, multi-collateral, transparent, decentralized stablecoin native to Aave. Suppliers and borrowers can mint the GHO coin by using assets they supplied as collateral to V3 on Ethereum markets, and they continue earning interest on underlying assets. Borrowing GHO is similar to other assets across the different Aave markets, but repaid interest goes to the Aave DAO rather than the asset supplier.
Our last review in 2020 observed that Aave was hot on achieving roadmap stages. However, the roadmap is no longer on the website and no team page, which is disappointing. Whilst we do not doubt that Aave is working hard behind the scenes and its community is probably well-informed, more transparency would help improve interest in the protocol for those who know little about Aave.
The Aave blog is up to date and live on the website. It is probably the best place for updated information, as the Twitter account isn't as active as expected for a protocol of this size.
Aave vs. Compound
Aave and Compound are both overcollateralized cryptocurrency lending protocols and operate similarly—both protocols pool lenders' assets into liquidity pools, which fund loans.
They both have a governance token and are two of the largest protocols in DeFi in terms of "assets under management" (AUM). However, Compound is less complex but does not offer as many features as Aave.
Aave offers stable Interest rates, but Compound does not. Aave allows you to switch between stable and variable interest rates; Compound does not. Aave has Flash Loans, but Compound does not.
On paper, Aave seems objectively better than Compound as a cryptocurrency lending protocol. However, there are two advantages Compound has over Aave. The first is that it is more user-friendly.
Not having as many features makes it easier for new users to understand and navigate. Compound incentivizes users to participate in the protocol by providing lenders and borrowers with a small fraction of COMP tokens every few seconds.
In summary, the key differences between AAVE and Compound.
- Native token: AAVE is a native governance token for Aave, for token holders to vote on the direction of the protocol. COMP is the governance token for Compound protocol.
- Different Ways of Determining Interest Rates: Aave uses the Utilisation rate of crypto assets to determine interest rates, whereas Compound uses algorithms based on supply and demand for each asset. Aave supports various crypto assets for borrowing, and Compound uses cTokens for lending and borrowing.
- Debt Closure if Under-Collateralized: If the collateral for borrowing falls lower than the borrowed amount, Aave rewards liquidators to close debt positions, and Compound's Comptroller does the same.
- Total Value Locked: Aave's Total Value Locked is $4.98B. Compound's TVL is $1.3B, and $885M for V3.
Aave New Developments 2023
Aave (AAVE) companies added a new open governance model (LIPS) and recently launched Lens Protocol, an NFT-powered, decentralized social media platform. LIPS (Lens Improvement Proposals) uses elements from Ethereum and Aave improvement proposals models.
Lens raised $15 million to help build and expand the new platform. The functionality will undoubtedly be unique for a decentralized platform, as users can block users on-chain, as you can on Facebook or other centralized social media channels.
Lens built the protocol on top of Polygon, an Ethereum scaling solution. Lens community members can tokenize social data with NFTs and smart contracts and have the power to propose improvements to the protocol.
"Designed to be interoperable, Lens can be integrated with other Web3 applications. This allows creators to build their own custom social media experiences." Source: Lens
Aave founder Stani Kulechov stated that the "Lens Protocol V2 takes decentralized social media and monetization opportunities to a new level."
The new platform should attract content creators, developers and interested users in the decentralized social media aspect. It will be interesting to see how Lens shapes up over time. With Elon rolling out X, amid the debacle argument that Meta owns the "name", most of us are tired of the big tech, centralized social media companies and eager to try something new.
Aave is a promising project and a behemoth in the DeFi space. Compared to DeFi lending protocols, it offers an arsenal of features, assets, and development tools to allow others to implement these same features into their own DeFi projects.
One of the unique features of Aave is the Flash Loans. Proponents of Flash Loans argue (and rightfully so) that it allows people without absolutely no assets to try their hand at quickly turning a profit in DeFi.
Perhaps the most famous case of this involves a “hacker” who used a Flash Loan with $10 USD to turn a profit of nearly $400,000 USD using arbitrage. Doing something like this without incurring a substantial amount of debt or risk is impossible in classical finance and opens a whole new world of potential.
In April 2023, according to several reputable sources, a Flash loan exploiter got away with $10 million in stablecoins with Yearn Finance and Aave.
Peckshield, a leading blockchain security company, one of Aave's security auditors, reported that the origin of the exploit was not related to Aave. Rather, it was due to a misconfigured uYSDT. The consensus seems to be that it did not affect V2 or V3.
Marc Zeller, founder of ACI, a blockchain consulting company, has worked with Aave since 2019.
Furthermore, Aave's founder Stani Kulechov seems to have a firm grasp of what DeFi needs to reach mainstream adoption. In an interview, he noted that it all boils down to quantifying risk and making it transparent to investors, especially institutional investors.
The fear of risk is why people turn away from cryptocurrency, and the reality is that it is a risky and volatile asset class. However, Kulechov believes it's vital to help people understand the risks, which could bring the wave of adoption the entire crypto space has been waiting for.
Finally, Kulechov noted the elephant in the room. How do you incentivize and operate services such as customer support without a centralized structure? It's a constant puzzle for a decentralized industry. However, it seems to be the driving force behind the Aave protocol, and we will undoubtedly see more evidence of this mission over time.
Although Aave has plenty of documentation on the internet, it would be beneficial to add the roadmap to the main website and have more synergy between shared information.
Frequently Asked Questions
Aave has a lot going for it as a major DeFi protocol. Founded in 2017, the Aave team have worked hard to differentiate itself from the market. AAVE is still a relatively new token but has done well, once reaching over $666 all-time high. Depending on your definition of "good", AAVE could be one to watch when the crypto market returns to a bull market.
Aave minimizes risk as much as possible, but nothing is entirely risk-free. There are two potential risks: -
- A bug or hacker gets into a smart contract code
- Liquidation risk
- Impermanent Loss
The Aave protocol code is open-source, public, and audited by multiple security companies. In addition, Aave operates a bug bounty program and Safety Module, a safe backstop of $283,513,952 in case of protocol insolvency.
One of the potential disadvantages of Aave is the risk of over-collateralization. When someone borrows, they must contribute more value than the loan. For example, if you borrow $100 of assets, you may need to provide $150 of assets for collateral.
There are also criticisms against the centralization of wealth in the top 10% of Aave holders.
If you deposit assets in the liquidity pools, you can earn from the distributed interest collected from borrowers.
Aave is trying to solve some of the most frustrating issues in traditional lending services. The main objective is to help users transition from centralized to decentralized finance services.
Disclaimer: These are the writer’s opinions and should not be considered investment advice. Readers should do their own research.