Aave is one of the most popular platforms in the cryptocurrency world of decentralized finance (DeFi). It allows you to lend and borrow numerous cryptocurrencies without a third party. It also lets you temporarily borrow over a billion dollars of cryptocurrency using something called a Flash Loan. Aave is licensed in the UK to provide financial services. It is the first DeFi platform to secure official licensing. The team has been working hard to bring in institutional investors.
Who made Aave?
Aave was created by Stani Kulechov, a Finnish entrepreneur who studied law. In contrast to many founders in the crypto industry, Stani is very aware that legacy institutions are skeptical of cryptocurrency. He knows that the most important thing that cryptocurrency projects need to be able to do is properly measure risk to investors and provide A+ customer support and communication. This is a big part of why Aave is one of the largest projects in DeFi. The platform holds nearly 1.4 billion USD worth of cryptocurrency assets at the time of writing.
How does Aave work?
Aave is built on the Ethereum blockchain. If you are not familiar with Ethereum, it is a cryptocurrency which also doubles as a platform where you can create decentralized applications. These are very similar to centralized applications that we use every day, except that their operations are divided between all of the computers in the network and not held on a centralized server.
Decentralized applications are built using smart contracts which are often impossible to modify once they have been released. This is a blessing because nobody can tamper with the application. It is also a curse because if the application is improperly designed, either someone could exploit it or the platform could crash and lock all of the deposited funds in it forever. This is why auditing (reviewing) code is very common in DeFi. Aave has had its code audited many times.
Aave lets anyone borrow Ethereum-based cryptocurrencies. No credit checks or identity checks are required and there is no term to pay back the loan – you could theoretically keep the loaned amount forever. This is possible to do because all loans on Aave must be overcollateralized. This means that if you want to borrow money, you have to first deposit more money than you are borrowing. This works well if you are looking for a short term loan and do not want to sell your Ethereum-based cryptocurrency. Loans are also used by expert cryptocurrency traders.
Since everything is measured in US dollars, cryptocurrency loans can be quite tricky. This is because the US dollar amount of the money you locked to borrow cryptocurrency might change. If the price was to drop, then you would be undercollateralized (not have enough money locked to borrow). If this happens, the assets you locked are liquidated (sold to other users on the platform at a discount). If the price of your collateral goes up however, you can go back and borrow more. Most people prefer to use stablecoins for borrowing and lending however, since they are pegged (copy) the price of a US dollar.
Lenders are incentivized to provide their cryptocurrency to Aave so that borrowers can borrow other types of cryptocurrencies and not just the ones they locked up as collateral. This is done by pooling their money together into lending pools. This also makes it possible for them to remove their money from Aave whenever they want with no penalties. When providing cryptocurrency to lending pools on Aave, lenders can earn up to 30% interest on their locked funds (compare this to 1-3% for banks!). They can also buy borrowers’ liquidated collateral at a discount.
Aave Interest Rates
Aave offers two interest rates for borrowing assets: a stable rate and a variable rate. Lenders are always subject to the variable rate. The dynamic rate depends on the supply and demand for the cryptocurrency. If there is low supply in a lending pool and high demand for that cryptocurrency from borrowers, the interest rates for both lenders and borrowers becomes very high.
This gives them incentive to lend their cryptocurrency to earn huge profits and deters borrowers from borrowing too much. The stable interest rate is the average of the last 30 days of interest for the cryptocurrency. Interest accumulates every second and fluctuates for lenders and for any borrowers not using the stable interest rate. Sometimes the stable interest rate is better than the dynamic rate, but other times it may be worse.
Aave Flash Loans
Aave allows anyone to borrow all of the money on the platform as long as they pay it back within 1 Ethereum block (12 seconds). This is possible because all transactions on Ethereum are only updated once every Ethereum block. This means that during that 12 second window, you can do just about anything you want with that money so long as everything is paid back at the end. If it is not paid back, all of the transactions you made are automatically reversed in Ethereum.
The utility of Flash Loans is something called arbitrage trading. This is when prices for the same cryptocurrency are slightly different on different cryptocurrency exchanges or platforms. With the right timing, you can make a lot of money. One user was able to earn over 360 000$USD using a Flash Loan. He bought a bunch of cryptocurrency from one exchange at a cheap price, sold it on another for a higher price, paid back the loan and kept the difference. Aave has made the Flash Loan code publicly accessible so that any other DeFi platforms can offer their own Flash Loans.
Why is Aave important?
Aave has opened the world to new ways of investing and managing money. Not only is it able to provide easy access to loans, but it rewards lenders with interest rates which are much higher than anything a bank could provide. The Flash Loan smart contract that it created also has serious potential, and more exciting technologies are still being developed by Aave and many other DeFi projects!