Aave is a decentralized money market running on the Ethereum blockchain that enables users to lend and borrow a range of crypto assets. Aave distinguishes itself by the range of cryptocurrencies in which users can take out loans, and by letting lenders earn passive income on the funds they make available for borrowers.
Aave was created in 2017 by developer Stani Kulechov, who had been exploring the potential for Ethereum to change the traditional financial system. Aave was originally launched as ETHLend, with the native token LEND, after an initial coin offering (ICO) raised $16.2 million. Kulechov’s original vision was to create a platform that would connect cryptocurrency lenders and borrowers, matching loan requests with specific offers. However, adverse financial conditions in 2018 prompted a reappraisal of the ETHLend concept and encouraged Kulechov to adjust and rebrand his project as Aave.
ETHLend was relaunched as Aave in 2020. The key feature introduced with the relaunch was Aave’s algorithmic money market function. Where ETHLend would individually match borrowers with suitable lenders, Aave implemented a liquidity pool system, with crypto loan assets pooled together and interest rates determined algorithmically depending on the type of asset being borrowed. Under the new system, if an asset is in short supply, interest rates are set higher in order to encourage lenders to contribute more – conversely, if there is a plentiful supply of an asset, interest is set lower in order to encourage borrowers to take out loans.
Aave facilitates loans in a variety of cryptocurrencies however under the pool system, borrowers must deposit a collateral amount greater than the amount they borrow. If a borrower is seeking a loan of $10 worth of Ether, for example, they must provide a deposit of more than $10 in another cryptocurrency. To account for the volatility of the crypto markets, the Aave protocol has an algorithm that automatically liquidates a borrower’s collateral if its value falls below a specified ratio. Each loan on the network is managed by a smart contract, verified by third-party auditors.
In rebranding, Aave also introduced the AAVE token. Using the AAVE token on the blockchain offers advantages: users that submit AAVE as collateral receive a discount on transaction fees, while users that borrow AAVE are not charged a fee. AAVE holders also gain governance rights over the Aave network, based on the amount of AAVE that they hold.
aTokens: The Aave protocol’s passive income function is based on a second type of token, known as the aToken. Issued at a 1:1 ratio upon the deposit of assets into Aave’s liquidity pool, aTokens are characterised depending on the cryptocurrency deposited and burned upon payback: depositing DAI, for example, results in the generation of aDAI.
aTokens are interest bearing which means that lenders accrue interest when loans are issued from the pool in which they deposited their assets. Interest is accrued in real time and sent directly to users’ wallets.
Flash loans: In addition to facilitating loans in a variety of cryptocurrencies, Aave also offers a flash loan service. Flash loans draw on the unused liquidity within the pool to allow borrowers to take out uncollateralized loans and then return the loan as part of the same transaction – with a 0.09% fee.
Flash loans are intended to allow borrowers to capitalize on short-term financial opportunities in crypto markets, leveraging price differences with fast trading activity within the time it takes to add a single block to the chain. If a loan is not paid back within the same block, the transaction is reverted and funds returned.
Rate switching: Aave has also introduced a rate switching service to address the volatility of the crypto markets. Rate switching essentially allows borrowers to lock in the interest rates of their loans or choose to stick with floating rates. In practice, this means that borrowers who expect interest rates to rise when they borrow from the Aave liquidity pool can choose to fix their interest rate.
Aave was designed to act as a completely secure and decentralized ecosystem of borrowers and lenders, offering access to users all over the world and allowing lenders to earn passive interest income on assets they contribute to the liquidity pool.
Beyond its native defi purpose, Aave is open source which expands its functionality by enabling the development of a variety of third party applications on the Ethereum network. To date, Aave has partnered with a number of developers, including:
Axie Infinity: Aave has partnered with the Ethereum-based game known as ‘Axie Infinity’ that allows players to win Aave tokens through skilful gameplay. Aave has also developed an Aave NFT for the game in the form of a unique character.
Pixelcraft Studios: Aave has invested in the Singaporean Pixelcraft Studios for the development of Aavegotchi, a game that allows players to collect Tamagotchi-style NFTs powered by the Aave protocol.
Balancer: Aave has partnered with Balancer to develop the Balancer V2 Asset Manager. The app will allow unused assets in the Balancer liquidity pools to earn interest on the Aave network. The Asset Manager will serve as a bridge that facilitates transfers between the networks.
Aave’s future objectives include a goal to allow anyone to develop and deploy their own money market on the Ethereum blockchain. Aave has released a list of parameters in order to ensure that market creators develop their markets in accordance with the Aave Risk Policies. Aave also intends to complete the transition to a fully decentralized autonomous organization (DAO), a process that involves the gradual ceding of network control to the Aave stakeholder community.
- What is Aave?