An offshoot of the decentralized finance (DeFi) model, Aave is a digital money exchange market for financial transactions – but in cryptocurrency form. It also has a token called AAVE.
Did you know that over $10 billion of total value is currently locked (TVL) on Aave?
In this article we’ll cover why AAVE has this much locked up, and what makes it one of the promising players in the decentralized finance markets.
What is AAVE and DeFi?
To understand Aave we must first understand DeFi.
Most people look to banks to manage all financial transactions. The banks act as a third party or a regulatory body for financial transactions between people. Usually they have their own rules to adhere to.
DeFi changes this.
It removes middlemen like banks and regulatory bodies and implements a simple concept called smart contracts in their place. These smart contracts allow two parties to perform traditional financial transactions and use traditional financial services, in a decentralized world. Everything from deposits & loans, asset trading, futures contracts, savings, and more can be managed with smart contracts.
Groundbreaking, right? Especially when applied to finances.
DeFi and the smart contracts that power it, run on the Ethereum network. A decentralized open-source blockchain protocol, second only to Bitcoin in market capitalization, Ethereum allows any DeFi project to program their own smart contracts to manage their own products and services.
Aave can be considered a decentralized lending system that is built from the Ethereum blockchain.
Users can borrow money, and lenders can lend it, paying and earning interest to each other via the smart contracts that run the Aave system. And just like traditional borrowers who are required to offer collateral to borrow money, cryptocurrency borrowers also must offer crypto collateral to borrow cryptocurrency.
Aave was created by the developer Stani Kulechov in 2017.
Interestingly, Aave was first called ETHLend, and even raised an ICO (Initial Coin Offering) with its native LEND token.
An ICO may sound similar to an IPO (Initial Public offering) because it is. Just as when a private company offers its shares to the public to raise money (an IPO) so too could a cryptocurrency company offer early crypto an initial coin offering (ICO). Both are used to raise money to further the development of the company.
The true vision behind Aave was to explore possibilities in revolutionizing the traditional financial system through the Ethereum blockchain. The focus was to decentralize the financial loans market.
Kulechov wanted to create a platform where lenders and borrowers of cryptocurrencies could connect and match loan requests with promising offers.
In 2020 ETHLend was relaunched as Aave with a custom Algorithmic based money market model. Called the liquidity pool system, this model acts as a buffer for the intense volatility of cryptocurrencies. The borrowers under the pool system have to deposit collateral in the form of cryptocurrencies (other than Aave) greater than the amount they borrow.
The rate of interest rates is dependent on the supply of the assets in the liquidity pool. So if the supply is high, the interest rates are low, so borrowers can take out more loans. Conversely, when the asset supply is low, the interest rates are higher. This inspires lenders to lend more in the hope of gaining additional interest.
However, to eliminate defaults and reduce risk, the Aave protocol automatically liquidates a borrower’s collateral if its value falls below a specified ratio.
The whitepaper on Aave showcases the early visions of a decentralized loan market without the need for complex regulatory procedures.
What does AAVE do?
Source: Medium.Monolith spotlights
Aave is a protocol of lending pools where borrowers and lenders are both involved. Several lenders may deposit funds (of various cryptocurrencies) into something known as a pool or lending pool. Borrowers or those who need money (loans) can draw from these pools based on the amount of collateral they offer.
Leveraging smart contracts, automatic liquidations, and other algorithmic assessments, Aave allows users to borrow and lend without requiring a credit check.
Aave issues two types of tokens for different reasons. These are :
- aTokens – Issued to lenders for collecting interest on deposits
- AAVE token – Native token of Aave
The AAVE cryptocurrency offers holders several advantages. For instance, AAVE borrowers don’t get charged a fee if they take out loans denominated in the token. Additionally, borrowers who use AAVE as collateral get a discount on fees, further incentivizing the use of their tokens.
Stali Kulechov, AAVE’s CEO said in an interview recently:
“Since there are no financial intermediaries involved, suppliers can earn historically higher interest rates than they would normally in today’s low and negative interest rate environment, making DeFi an attractive alternative for corporate treasuries, hedge funds, and more looking to maximize their yield.”
Aave has continued to improve and develop since its inception, pioneering new functions like its flash loans, which allow individuals to borrow cryptocurrency without collateral. Typically used by traders, these loans are just one of the ongoing features the Aave platform offers.
Importance to Investors
Source : Defi pulse
The vision behind Aave was to create an unregulated financial model where lenders and borrowers could trade or render services. Lenders contributing to the liquidity pool could make passive income from the interests, and those who need loans can receive them without a strict regulatory intervention.
While interest rates offered by Aave are higher compared to the standard bank rates, these rates change based on the supply and demand of the specific crypto asset or token in the Aave liquidity pool. Interest can range from 0.02% APR (Annual Percentage Rate) to over 12% APR.
Depending on which side of the equation you stand on (borrower or lender) the rates can work heavily in your favor at various points in time.
Aave is one of the most extensive lending protocols, and its token is one of the most popular tokens purchasable on Coin Market Cap. The price reached an all-time high of $661.69 USD on May 18th 2021, according to CoinGecko.
Despite this, Aave has huge plans for the DeFi space. It’s working on a new platform, Aave Arc, which intends to be a gateway to decentralized finance for institutions.
The main feature of this new platform is to enter a private liquidity pool instead of the public pool model that it currently uses. This will likely appeal more to Institutional investors potentially signaling the entry of Banks and Institutional funds into the DeFi space.
Aave plans to continue to push forward with innovative new offerings and expansive lending and borrowing options.
As a leader in the DeFi space, this project may be one to pay attention to.
Ultimately, the next phase of DeFi, with AAVE as one of its innovators, should make the industry more accessible to everyday users and institutions alike while building even greater trust through better protocol, and product transparency that clearly identifies risks to its users.
If you’re interested in learning more about AAVE, take a look at the following resources :
Whitepaper on Aave
The websites, articles, and content that was used to make this article: