Decentralized finance (DeFi) has been a scorching hot topic in crypto in the last few months. Cryptocurrency lending protocols such as Compound, MakerDAO, and Aave have been the main attractions to this financial spectacle with good reason.
A lot has changed since we covered Aave in April of 2019 when it was still known as ETHlend. Case and point: it has risen to become one of the most popular DeFi apps since its rebranding and redesign.
Just in the last few months Aave has introduced some of the most remarkable features currently found in DeFi such as Flash Loans and Interest Rate Switching. LEND, its native token, has also seen an expansion in use-case as the development team gradually moves towards turning Aave into a full-fledged decentralized autonomous organization (DAO).
As you will see, Aave is not “just another cryptocurrency lending platform” but is one of the undisputed leaders in the world of DeFi.
What is Aave?
Aave (pronounced “ah-veh”) is a decentralized cryptocurrency lending platform. In fact, it was the first DeFi lending protocol when it launched its first main net as ETHlend in 2017 (this was before DeFi was even a thing!).
Aave means “ghost” in Finnish
ETHlend/Aave’s founder Stani Kulechov is passionate about working with leading developers from other projects within the DeFi space and is hyper-focused on ensuring the platform appeals to institutional and retail investors both inside and outside of cryptocurrency.
To briefly recap, ETHlend was a sort of marketplace where borrowers and lenders could negotiate terms without a third party. You can think of it as a job posting board but with loans instead. The platform was moderately successful, but the team decided they were “ready to be serious players” in the DeFi space.
This led to the launch of Aave in January of this year when the Aave mainnet launched and introduced a completely new protocol to its users along with a few novel features that have changed DeFi forever.
How Does Aave Work?
Aave allows users to lend and borrow cryptocurrencies in a decentralized and trustless manner. Simply put, there is no middle-man involved and no Know Your Customer (KYC) or Anti Money Laundering (AML) documentation is required to use the platform.
In a nutshell, lenders deposit their funds into a “pool” from which users can then borrow. Each pool sets aside a small percentage of the asset as reserves to help hedge against any volatility within the protocol. This also conveniently allows lenders to withdraw their funds at any time.
How Aave works in an image. Image via Aave Docs
Aave offers 17 different assets for lending and borrowing including the Dai stablecoin (DAI), USD coin (USDC), True USD (TUSD), Tether (USDT), Synthetix USD (sUSD), Binance USD (BUSD), Ethereum (ETH), ETHlend (LEND), Basic Attention Token (BAT), Kyber Network (KNC), Chainlink (LINK), Decentraland (MANA), Maker (MKR), Augur (REP), Synthetix Network (SNX), Wrapped Bitcoin (wBTC) and 0x (ZRX).
While this is an impressive list indeed, not all of them can be used as collateral for a crypto loan.
Like other lending protocols within the space, Aave offers overcollateralized loans, meaning that a user must lock an amount of collateral that is larger (in USD) than the amount being withdrawn. This amount depends on the asset and ranges from 50-75%.
Cryptocurrencies on Aave lending protocol
If the USD value of a user’s collateral falls below the necessary collateralization threshold, their funds are posted for liquidation and can be purchased at a discount by other users within the system. Aave uses Chainlink (LINK) as an oracle to collect price data about assets on its platform. Interest is accrued by the second and you can see it increasing in real time.
Aave Interest Rates
Aave offers two interest rates: stable and variable. The variable interest rate is determine 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 both lenders and borrowers (and vice versa).
The stable interest rate is the average of the last 30 days of interest rates for the asset. This interest rate history can be seen when lending or borrowing an asset on the platform. You can switch between stable and variable rates at any time (you just have to pay a small ETH gas fee).
Whenever funds are deposited on Aave either as a lender or as collateral when borrowing, the user is given an equivalent amount in aTokens. For example, if you deposited 100 DAI into Aave, you would be given 100 aTokens. The function of these tokens is to allow you to earn interest.
aTokens on Aave
Every second, a small fraction of corresponding aTokens are added to your Ethereum wallet in accordance with the APR interest rate for your asset. These can then be exchanged for the equivalent amount of the underlying asset in Aave at the time of withdrawal.
Aave Flash Loans Explained
Flash loans are something that many consider to be the next generation of finance and is arguably Aave’s most famous contribution to DeFi so far. This controversial function lets users borrow large amounts of cryptocurrency with absolutely no collateral.
How this works at the technical level is quite complicated but it is conceptually easy to understand. The cryptocurrency that is borrowed must be paid back by the time the next Ethereum block has been mined. If it has not been paid back, every transaction which occurred in that span of time is canceled. A 0.3% fee is paid for every flash loan.
An example of how cryptocurrency Flash Loans work. Image via Aave
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 LEND Cryptocurrency
In 2017 when Aave was still known as ETHlend, it launched a multi-round ICO with its ERC-20 token LEND at a price of 1.6 cents USD. Over 1 billion of its 1.3 billion total supply was sold, raising over 16 million USD. Roughly 23% of the tokens were kept by the founders and developers of the project.
The token was and continues to be used to pay for fees on the protocol and is burned when doing so. This means the LEND token is a deflationary asset. While Aave is also planning to use its LEND token for governance, this has yet to materialize at the time of writing.
Keeping in tune with its theme of transparency, Aave clearly defines their roadmap on their website’s About page. The only problem is that it ends in May of this year and does not show any future milestones for the project.
Every single one of them was met and some of the important ones included successfully launching the protocol, integrating the Chainlink oracle, adding support for MyEtherWallet and Trust Wallet, and the integration of the Uniswap Market on Aave which allows traders to do all sorts of magic with Aave’s Flash Loans.
The roadmap of the Aave protocol. Image via Aave Docs
Most of the chatter surrounding Aave’s development has been about the introduction of governance to the protocol. This would allow holders of the LEND token to have a say in the future of the project, turning it into a DAO.
While the exact mechanics of this have not been officially announced, in a recent interview with Messari, Stani Kulechov stated that holders of LEND will be able stake the token to earn a fraction of the interest being paid on loans. This pool of staked LEND tokens would also function as emergency reserves for the protocol, with small amounts being liquidated to maintain stability during black swan events.
Aave vs. Compound
Aave and Compound are both overcollateralized cryptocurrency lending protocols and operate in effectively the same way. Both pool the assets of lenders into lending pools from which borrowers can take, they both have their own governance token, and they along with MakerDAO are the largest protocols in DeFi in terms of “assets under management” (AUM). That being said, Compound is much less complex and consequently does not offer nearly as many features as Aave.
The Compound Finance app dashboard. Image via Compound Dashboard
Aave offers stable Interest rates, Compound does not. Aave allows you to switch between stable and variable interest rates, Compound does not. Aave has Flash Loans, Compound does not. Aave has 17 assets for lending and borrowing, Compound has 9. Best of all, Aave lets users borrow a higher percentage of the underlying collateral (75% vs Compound’s 66.6%).
Aave collateral and liquidation thresholds. Image via YouTube
On paper, it seems that Aave is objectively better than Compound as a cryptocurrency lending protocol. However, there are two major advantages Compound has over Aave. The first is that it is much more user-friendly.
The fact it does not offer as many features fundamentally makes it easier to understand and navigate for new users. Second, Compound gives users much more incentive to participate in the protocol by giving both lenders and borrowers a small fraction of COMP tokens every few seconds.
The final element which divides the two projects is that Compound is, in essence, “finished” whereas Aave is just getting started. Compound is in its final stage of handing the protocol off to its community, at which point it will be a fully operational DAO with absolutely no intervention or influence from its original development team. Aave only just launched this year and has yet to implement the community governance required to be a DAO.
LEND Price Analysis
You may be surprised to find that the price of Aave’s LEND token has never risen above 1$USD. The LEND token made its debut on the crypto market in November of 2017 and got swept up in the historic bull run which began a month later. It reached its all time high of over 40 cents USD before crashing down to below 2 cents and eventually 1 cent where it remained until the end of 2019.
The price history of LEND cryptocurrency. Image via CoinmarketCap
As you might have guessed, the introduction of the new Aave protocol in January of this year has sent the LEND token into orbit. It gradually appreciated in price from 1 cent USD to over 14 cents USD in June of this year when DeFi really started heating up.
This is somewhat impressive given the token’s limited use as an optional means of paying fees on the protocol. It will be interesting to see what effects the introduction of governance will have on the price of LEND once it is rolled out.
Where to Get LEND
While the LEND token is listed on about a dozen exchanges, unfortunately the only reputable one with any volume is Binance. The LEND token has a relatively 24-hour volume given its market cap, and it appears that almost half of that volume may be fake.
This low volume concentrated on a single exchange could leave the open open to some serious market manipulation, so be cautious when buying or selling LEND!
LEND cryptocurrency wallets
Since LEND is an ERC-20 token, it can be stored on just about any cryptocurrency wallet which that supports Ethereum. The list is quite long but the best-known digital wallets include MyEtherWallet (web), MetaMask (web), Exodus (desktop and mobile) and Atomic Wallet (desktop and mobile).
Hardware wallets include Trezor, Ledger, and KeepKey. Note that you can only interact with the Aave protocol using a handful of wallets including MetaMask, Ledger, and the Coinbase wallet.
Our opinion on Aave
Aave is an extremely promising project which appears to have flown somewhat under the radar. Compared to other 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.
The top 5 lending protocols in DeFi. Image via DeFi Pulse
Most importantly, the fact that it currently occupies 3rd place as a brand new and very much unfinished DeFi lending platform suggests that this is only the beginning for this project and the valuation of its LEND token.
That being said, Aave suffers from the same issue which plagues Compound and just about every other DeFi lending protocol: who would actually use it outside of the crypto space?
The advantage of loans as a service is that it allows you to borrow more than what you currently own, sometimes substantially more. Borrowing less than what you currently own is almost entirely pointless unless you are planning on doing some DeFi magic.
One of the many controversial events involving Flash Loans: . Image via Trust Nodes
This brings us to Flash Loans. If there is anything that should be remembered about Aave, it is this extremely unique feature. 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.
Furthermore, Aave’s founder Stani Kulechov seems to have a firm grasp of what is necessary for DeFi to reach mainstream adoption. In a recent interview, he noted that it all boils down to quantifying risk and making it transparent to investors, especially institutional investors.
Aave CEO explains what is necessary for DeFi to achieve mainstream adoption: . Image via YouTube
Risk is fundamentally why people turn away from cryptocurrency and the reality is that it is a very risky and volatile asset class. However, Kulechov believes that if this risk can be adequately communicated and explained then it will finally bring in the wave of adoption the entire crypto space has been waiting for.
Finally, Kulechov has noted something very important when it comes to DeFi: how do you incentivize and operate services such as customer support without a centralized structure? These sorts of questions may perhaps be why we have yet to see any solid documentation or explanation of the LEND token’s new tokenomics.
The Aave development team may just be creating a governance protocol that is as much of a game-changer as Flash Loans. Best of all, you can bet that they will be making that code open source too!
Feature Image via Shutterstock