What Is Aave Crypto Protocol?
One of the benefits of cryptocurrency — and one of the main drivers behind its creation — has always been its decentralized nature. That means cryptocurrency is not backed by any bank or banking system, government or other organization.
See: 3 Things You Must Do When Your Savings Reach $50,000
Bitcoin is recognized as the first cryptocurrency. Shortly after that, ethereum and other alt-coins launched. As cryptocurrencies grew in popularity, a decentralized lending protocol became necessary for people to borrow and lend cryptocurrencies. Enter: Aave.
What Is Aave?
In short, Aave is a pool-to-peer cryptocurrency loan platform.
Aave is one of the largest cryptocurrency lending protocols. Created by Stani Kulechov and his team of coders in 2017, it was originally called ETHLend because of its function and the platform it operates on: the Ethereum blockchain.
In September 2018, the platform rebranded as Aave — rhymes with “shave.” Aave is Finnish for “ghost,” a reference to the anonymous and decentralized nature of crypto borrowing and lending.
Aave defines itself as a “decentralized non-custodial liquidity protocol” that allows users to earn interest, borrow assets and build applications.
There are currently three versions of Aave, each of which established upgrades to the network: V1, V2 and V3.
Benefits of Aave
Aave is primarily known for its crypto lending and borrowing capabilities.
The service uses smart contracts to secure transactions. This eliminates the “middleman” of a bank and allows users to earn interest by lending their crypto. Because there is no loan officer to approve or deny loans, transactions can take place instantaneously.
Because the platform is open source, anyone can interact with the protocol, build a third-party service or interact directly with the smart contracts.
Understanding AAVE Tokens
The AAVE token was designed as part of AAVE’s governance through its Decentralized Autonomous Organization, or DAO. Users can vote on Aave Improvement Proposals using AAVE tokens.
Users can also stake AAVE to earn rewards.
Aave modifies the concept of peer-to-peer lending to “pool-to-peer” lending, where funds are deposited into a central location — deemed a “liquidity pool” — to be borrowed and loaned as needed.
While the automated lending capabilities of Aave through smart contracts make transactions fast, inexpensive and democratized, it also means borrowers have no recourse if they can’t meet the loan terms. That is, if you can’t pay back your loan, the system will automatically liquidate your collateral with no questions asked and no way to explain yourself or ask for a loan extension.
On the other hand, this is a tremendous benefit to lenders, who can loan assets with no risk of not getting paid back.
Pool-to-peer lending means you don’t have to seek out a specific borrower or lender. All funds available to borrow are placed in a pool. This keeps the transaction anonymous and safe for lenders and borrowers.
How to Lend Crypto on Aave
Users can earn interest by lending their crypto funds through Aave. To contribute assets to the lending pool, you will want to click on “Markets,” and select the blockchain and version of Aave you wish to contribute to.
Choosing the Version
Aave V2 is known as the world’s largest public lending market, according to CoinDesk.
But V3 offers a number of advantages, including lower transaction fees and the ability to operate across virtually all blockchains through a feature called “Portal.” This allows borrowers and lenders to trade in not just crypto on the Ethereum 2.0 blockchain, but also on Solana, Avalanche and others.
Choosing an Asset
Once you’ve selected your blockchain, choose the asset you want to lend. Different assets have different rates of return. Interest is paid back in the same form of crypto you deposited, so if you deposit ethereum into the liquidity pool, you will earn interest, represented as an APY or Annual Percentage Yield, in ETH tokens.
You’ll need an in-browser crypto wallet to deposit funds and confirm the transaction.
How to Borrow Crypto on Aave
If you want to borrow assets on Aave, you’ll need to post collateral first. In traditional lending, the amount you can borrow and your loan terms will depend on your credit score, income and perhaps other factors. On the Aave platform, borrowers are evaluated based on the amount of collateral they supply, plus something called a “health factor,” which refers to the relative safety of the asset you deposit compared to the asset you are borrowing.
Limits and Conditions
Aave limits the amount you can borrow to 80% of the current value of your loan’s collateral. This figure, as in real estate lending, is called the “loan-to-value” ratio.
Loans have no specific repayment dates, or terms, but if the collateral you deposited drops below 80%, some of your collateral will be liquidated to cover that portion of the loan. Up to 50% of your pledged collateral may be sold to reach an acceptable LTV.
Loans must be repaid in the same form of crypto they were made.
Borrowing assets through Aave can carry high fees, ranging from just 2% of a loan up to 30% APY or more. Aave users also pay network fees, called gas fees, for conducting business on the Ethereum network.
Flash Loans on Aave
You can avoid collateral when borrowing on the Aave platform by using something called Flash Loans. Flash Loan funds are borrowed and paid back within the same transaction, reducing the risk.
However, these loans are typically reserved for developers, since they require a degree of technical knowledge to create the smart contract. Flash loans have lower fees than collateralized loans.
Non-technical investors can use Flash Loans through services like Collateral Swap and Defi Saver.
While Aave is recognized as one of the largest defi borrowing and lending platforms, it is not the only one. Other cryptocurrency lending protocols include:
Each of these has different rates, fees and supported cryptocurrencies.
The Future of Aave
Aave appears to be one of the fastest growing, well-supported platforms. In 2022, Aave developers announced Lens Protocol, a decentralized social media platform permitting users to store — and profit from — NFTs of their own creation.
Built on the Polygon network, Lens Protocol leverages blockchain technology to create a “censorship-resistant” social media network where users can “own, control, and possibly profit from their own content,” according to Decrypt.
As a borrowing and lending platform for cryptocurrencies, Aave has many exciting benefits. Experts say that Aave should stay ahead of top competitors, MakerDAO and Compound, due to its security and compliance measures, rapid growth and innovation.
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- CoinDesk. 2022. "Aave: Understanding the Crypto Lending Platform."
- Decrypt. 2022. "What Is Aave? Inside the DeFi Lending Protocol."
- Decrypt. 2022. "Aave Launches Decentralized, NFT-Based Twitter Rival on Polygon."