What is Aave? Crypto borrowing and lending on Aave explained in simple terms
(In previous explainer articles, we have explored the basics of blockchain, cryptocurrency, Ethereum, and decentralised exchanges. It may be helpful to read about them first, before diving into how Aave works.)
Ethereum, which allows decentralised apps (DApps) using smart contracts to run on top of it, hosts Aave, which is one of the most popular decentralised lending systems.
On Aave, users interact directly with the network protocol (no middlemen are involved) to lend, borrow, and earn interest on their crypto assets.
Due to the nature of the Ethereum blockchain, apps like Aave utilise a distributed network of nodes (or computers) running the software. As such, users don’t need to trust a centralised institution to handle and manage their transactions.
How Aave works
Similar to UniSwap, the Aave protocol creates lending pools for users to lend or borrow crypto assets.
However, UniSwap is a decentralised exchange to swap and stake crypto assets, while Aave is a non-custodial protocol to borrow crypto and earn interest on deposits.
It must be noted that users need to post collateral on Aave before they can borrow.
The total value locked (TVL) in Aave is currently more than $11.4 billion, as per CoinMarketCap data.
The native currency of the network is AAVE - and is used as a governance token for holders to vote on proposals affecting the project’s roadmap and plans.
AAVE’s market cap is $1.64 billion, while its 24-hour volume is $205.5 million (at the time of writing this article). Further, the AAVE token has a maximum supply of 16 million while its circulating supply is 13.63 million.
The token is traded on more than 85 exchanges globally, and it's all-time high (ATH) was $666.86, which it touched back in May 2021.
On the Aave lending network, users may post collateral in the form of tokens known as DAI, and receive funds in the form of a special Aave interest bearing tokens.
Aave’s official website explains how it works: “Aave interest bearing tokens (aTokens for short) are minted upon deposit and burned when redeemed. The aTokens are pegged 1:1 to the value of the underlying asset that is deposited in Aave protocol. ATokens, such as aDAI, can be freely stored, transferred, and traded.
"While the underlying asset is loaned out to borrowers, ATokens accrue interest in real time, directly in your [the users’] wallet. Seriously, you can watch your balance grow every minute.”
Origins of Aave
Aave’s story starts in 2017, when entrepreneur Stani Kulechov and a team of devs released a product known as ETHLend through an Initial Coin Offering (ICO). Their idea was to build an Ethereum-based network for users to lend and borrow crypto directly with each other.
However, due to the 2018 crypto bear market and diminishing amounts of liquidity on its network, ETHLend lost traction, and was unable to directly match loan requests to loan offers.
Thus, Stani and his team revamped ETHLend into an algorithmic money market that leveraged liquidity pools to match loans, instead of directly matching loan requests and loan offers with each other. This overhauled product is known as Aave.
The team also introduced a mechanism for increasing interest rates for borrowing crypto assets from a particular liquidity pool if nearly all assets in that pool were nearly used up. This entices more users to deposit liquidity into the pool. If few assets in a pool are used, the interest rate is lowered, to encourage more borrowing.
Other Aave features
Aave allows users to borrow crypto assets that are not similar to the tokens they deposited as collateral. For instance, users may deposit ETH and withdraw a range of other crypto assets on the lending system.
On Aave, loans are usually overcollateralised, which means users generally need to deposit crypto worth more than the value of crypto they wish to borrow.
Aave also features a liquidation process that liquidates collateral based on the protocol’s collateralisation ratio. While explaining this concept is beyond the scope of this article, users are urged to understand the collateralisation ratio before depositing funds into Aave.
Aave has also been providing flash loans - an arbitrage opportunity where users can borrow a large amount of crypto assets without posting collateral, then repay the loan in the same transaction, while paying the relevant interest fee.
It has also launched an NFT game known as Aavegotchi.
Aave continues facing the challenge of overcollateralisation, and the lack of a traditional credit score system to determine if borrowers have the ability to repay loans with interest.
However, Aave continues to pioneer research and development in decentralised lending systems and more open and accessible financial systems.