Aave Explained: Crypto Lending & Borrowing Made Easy!

Aave, also known by its market ticker AAVE, is a decentralized lending protocol that offers automated borrowing and lending services to its users.

Originally built on the Ethereum blockchain, it has expanded to other blockchains like Avalanche, Fantom, and more.

Like most things Ethereum, Aave runs on smart contracts to automate the process. This can include how funds are distributed, how collateral is handled, and how fees are determined and collected.

Aave specialized in over-collateralized loans, which means those who deposit their crypto to be traded by others are very unlikely to lose out as there is always more deposited as collateral for the loan than is available to be loaned.

But what exactly is Aave, how does it work, and what makes it unique?
Today we find out!

Aave was founded by Stani Kulechov in 2017 and was developed by a team of developers from London, and is now based in Switzerland. In short, Aave is a decentralized lending protocol that lets users borrow and lend crypto.

Originally called ETHLend, the idea behind what would become Aave was to allow users to post loan offers and requests in a decentralized manner, thus creating a marketplace where users can lend and borrow money between each other without the need for trust between parties or a centralized broker.

Like most decentralized protocols, Aave doesn’t run its own blockchain and instead is an app built on top of other blockchains.

Initially, Aave found life on the Ethereum network as an ERC-20 token. However, Aave has since expanded to other blockchains such as Avalanche, Fantom, Harmony, Polygon, and more, with the launch of Aave V3 which included cross-platform compatibility.

Quite often people ask why, why would you want to borrow crypto with other crypto you have deposited? The short answer is arbitrage, where you find an asset for sale on one exchange cheaper than another, and you do a trade to keep the difference.

Let’s say you borrow $15,000 from Aave when the price of Ethereum is at $1,500 on one exchange and $1,510 on another.

You then proceed to buy 10 ETH for $15,000 from the first exchange and sell them for $15,100 on the second one, essentially profiting $100 just from one trade.

At the same time, you repay your $15,000 loan and you get your deposited crypto back. You are now $100 richer.

Aave would pioneer a smart contract technique known as Flash Loans to aid with this objective, but I will come back to that a little later.

First, let’s see how Aave works.

Aave is an automated market maker, which is essentially a decentralized market that runs on cleverly coded algorithms to ensure funds are always available to trade.

The assets available to be handed out as loans are deposited by other users, who are known as Liquidity Providers, into what are called Liquidity Pools.

The amount of interest charged on these loans depends on the utilization rate of the assets from within the Liquidity Pool.

If one asset in the pool is almost empty, the interest rate goes up to encourage Liquidity Providers to deposit more of that asset.

Alternatively, if the Liquidity Pool is almost full, it will offer a lower interest rate which will encourage more loan applications from the Liquidity Pool.

This clever balance manages to keep the markets trading 24/7, in a trustless manner, and without the need for human oversight.

How Aave makes sure it never loses the deposited funds is by ensuring all of its loans are over-collateralized. This means, if you want to borrow $1000 in BTC, you’ll need to leave more than $1000 in another cryptocurrency to get it.

On top of this, Aave has an automated settlement process where if the collateral falls below the Protocol Collateralization Ratio, the system may liquidate your capital to ensure the loan is repaid and you do not default.

How Aave works depends on which network it operates, but on the Ethereum network, it is an ERC-20 token, which is a token creation blueprint that ensures compatibility with the Ethereum blockchain.

It runs on a Proof-of-Stake mechanism, much like the ones I have talked about previously.

As I mentioned earlier, Aave pioneered the smart contract practice of Flash Loans.

This is a clever method to utilize smart contract technology in a way that is not possible in traditional finance.

To break it down to its most basic, let’s talk about that arbitrage opportunity I described earlier. Say you found a cryptocurrency selling on one marketplace for more than what it sells on another.

Through the creation of cleverly coded smart contracts, it is possible to borrow cryptocurrency without the need for any collateral to secure the loan.

You can then use this borrowed crypto to buy an asset, and then sell the asset, and complete the loan while pocketing the profit for yourself.

This is permissible, providing that you do it all within one block transaction and one smart contract so there is no risk to the person who is lending their crypto for no collateral.

Therefore, without needing to fully finance it, if you can create a smart contract that outlines the trade and can provably secure a profit for everyone involved within that single smart contract, Aave will let you do that.

But how about the tokenomics?

AAVE has a total supply cap of 16 million AAVE tokens, with around 14.5 million in circulation.

The initial supply distribution was distributed as follows. 30% went towards Core Development, 20% to User Experience Development, 20% to Management and Legal, 20% to Promotion and Marketing, and 10% to cover miscellaneous costs.

In total, only 3 million was kept in reserve to be used between the Safety Module, which safeguards the protocol against shortfalls, and the Liquidity Providers to encourage growth and platform adoption.

Aave is primarily used for governance and to secure the platform, as is customary for most Proof-of-Stake tokens.

In conclusion, if you’re looking to make some money off your crypto by loaning it out to others, and earning a piece of the interest, then Aave could be for you.

In the fast-evolving landscape of decentralized finance, Aave stands as a pioneering crypto protocol, which helped revolutionized lending and borrowing.

Through its clever smart contract system, Aave empowers users to earn interest on deposits and access liquidity through collateralized loans.

With innovative features like flash loans, Aave exemplifies the potential of blockchain technology to reshape traditional financial paradigms.

As the DeFi movement continues to change the future of finance, Aave remains at the forefront, showcasing the transformative power of decentralized, autonomous protocols.

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