As one of the emerging DeFi cryptocurrencies, Aave is a decentralized lending system that allows users to lend, borrow, and earn interest on cryptocurrency assets, with all transactions being without intermediaries.
Running on the Ethereum blockchain, Aave is instead a system of smart contracts that allows these assets to be managed by a distributed network of computers running Aave's software.
This means that Aave users do not need to trust a specific organization or individual to manage their money. They only need to trust that the company's rules will be enforced as written.
The Aave software allows for the creation of a lending pool that enables users to lend or borrow 17 different cryptocurrencies including ETH, BAT, and MANA.
Like other decentralized lending systems on Ethereum, Aave borrowers must collateralize their assets before they can borrow. Furthermore, they can only borrow up to the value of the collateral.
The borrower receives funds in the form of a special token called aToken, which is pegged to the value of another asset. This token is then encoded so that the lender receives interest on the deposit.
For example, a borrower can collateralize an asset with DAI and borrow with ETH. This allows borrowers to access various cryptocurrencies without fully owning them.
Aave may also introduce additional features, such as instant loans and other forms of debt and credit issuance that leverage the unique design characteristics of blockchain.
Who created Aave?
Aave is a for-profit company founded in 2017 by Stani Kulechov and based in Switzerland. Kulechov was trained in law in Helsinki and started Aave while still a student.
Initially, this company was called ETHLend, which raised $16.2 million in an initial coin offering (ICO) in 2017. During that time, the company sold 1 billion units of the cryptocurrency AAVE - initially named LEND.
The LEND cryptocurrency transitioned to AAVE at a rate of 100 LEND tokens for 1 AAVE, reducing the total cryptocurrency supply of the company to 18 million AAVE.
ETHLend differs from Aave in that, instead of pooling funds, this company seeks to connect lenders and borrowers in a peer-to-peer manner. In 2018, ETHLend was renamed Aave, meaning 'ghost' in Finnish. ETHLend became a subsidiary of Aave.
Other products and services announced at that time included a trading desk to handle large transactions, a game studio focusing on blockchain games, and a payment processing system.
How does Aave work?
Aave is arguably best described as the best lending fund system.
Participants deposit the amount they want to lend, which is then collected into a liquidity pool. The borrower can then withdraw money from these funds when they receive a loan. These tokens can be traded or transferred at the lender's discretion.
To facilitate this operation, Aave offers two types of tokens: aToken given to lenders so they can earn interest on deposits, and the AAVE token, which is the native token of Aave.
The AAVE cryptocurrency offers its holders several advantages. For example, AAVE borrowers will not be charged if they take out loans denominated in tokens. Additionally, borrowers using AAVE as collateral will also receive fee discounts.
AAVE holders can review loans before they are published to the public if they pay a fee in AAVE. Borrowers using AAVE as collateral can also borrow a bit more.
The data company Nomics has a more comprehensive list of AAVE's features.
Flash Loan
Aave allows certain loans, called 'flash loans', to be provided and settled immediately. These loans do not require upfront collateral and are processed almost instantly.
Flash loans take advantage of a feature that all blockchains have, where transactions are only finalized when a new transaction package, called a block, is accepted by the network.
Adding each new block takes time. For Bitcoin, that time is about 10 minutes. For Ethereum, that time is about 13 seconds. As a result, a flash loan on Aave will occur within this 13-second window.
Flash loans work as follows: The borrower can request money from Aave, but they must pay back that money and a fee of 0.09% within the same block. If the borrower does not do this, the entire transaction will be canceled, so no loan arises.
Thus, Aave does not bear the risk, and neither do the borrowers.
Borrowers may want to use flash loans to take advantage of trading opportunities or maximize profits from other systems built on Ethereum. Different cryptocurrencies can be automatically swapped using flash loans to generate trading profits.
Note: Flash loans have been combined to carry out attacks on lending systems built on Ethereum, sometimes successfully stealing hundreds of thousands of dollars in deposits.
Why is AAVE valuable?
AAVE plays a central role in managing the Aave software, allowing users to vote on changes to the rules and policies aimed at improving the AAVE software.
The Aave team has also launched the Safety Module (SM), where participants can stake their AAVE as insurance in case of liquidity shortages. Doing so will help those staking to earn more AAVE tokens, along with a percentage of the protocol fees.
In addition to this utility, AAVE derives its value from its limited supply and the fact that AAVE uses revenue from fees to buy AAVE and remove cryptocurrency from circulation.
Why use AAVE?
Traders or investors who believe that decentralized lending will continue to gain popularity may be interested in AAVE.
As of July 2020, the Aave system is one of the most dynamic decentralized lending systems based on Ethereum, having accumulated $158 million in total deposits. Competing lending platforms include Compound and Maker, which have over $600 million in deposits.
You may also want to use AAVE if you want a say in the rules governing the Aave system, voting on how to distribute fees earned from lending to AAVE token holders.
