dApp Dive: Aave
By: @0xLayerTwo
Aave, formerly ETHLend, is a decentralized finance (DeFi) protocol that lets people lend and borrow cryptocurrencies and real-world assets without having to go through a centralized intermediary. Aave is a for-profit company founded in 2017 by Stani Kulechov and based in Switzerland. Kulechov was trained in law in Helsinki and started Aave while still a student.
Like any lending arrangement, when users lend through the platform, they earn interest; when they borrow through the platform, they pay interest. The protocol is governed by smart contracts as opposed to lenders or bankers, and the loans are collateralized with cryptocurrencies.
Aave was originally built atop the Ethereum network, with all the tokens on the network also using the Ethereum blockchain to process transactions; they are known as ERC20 tokens. Aave has since expanded to other chains, including Avalanche, Fantom, and Harmony. The protocol itself uses a decentralized autonomous organization, or DAO. That means it’s operated and governed by the people who hold—and vote with—AAVE tokens.
Aave currently has pools for 30 Ethereum-based assets, including the stablecoins Tether, DAI, USD Coin, and Gemini dollar. Other markets include Avalanche, Fantom, Harmony, and Polygon, among others. Like other decentralized lending systems on Ethereum, Aave borrowers must post collateral before they can borrow. Further, they can only borrow up to the value of the collateral they post. Borrowers receive funds in the form of a special token known as an aToken, which is pegged to the value of another asset. This token is then encoded so lenders receive interest on deposits A borrower may post collateral in USDT, for example, and borrow in ETH. This allows a borrower to gain exposure to different cryptocurrencies without owning them outright.
Aave also provides pools for real-world assets, like real estate, cargo and freight invoices, and payment advances. For such pools, a partner company called Centrifuge helps brick-and-mortar businesses tokenize aspects of their operations. Once tokenized, investors can purchase (or hold as collateral) these tokens, which behave similar to bonds and earn a yield on their holdings. Thus, these assets can be used as collateral for real-world businesses to borrow cash.
Flash Loans
Aave allows certain loans, called “flash loans,” to be instantly issued and settled. These loans require no upfront collateral and happen almost instantly. Flash loans take advantage of a feature of all blockchains, which is that transactions are only finalized when a new bundle of transactions, known as a block, is accepted by the network.
Adding each new block takes time. On Bitcoin, that interval is roughly 10 minutes. On Ethereum, it’s 13 seconds. An Aave flash loan therefore takes place in that 13-second period.
The flash loan works like this: A borrower can request funds from Aave, but they must pay back those funds, and a 0.09% fee, within the same block. If the borrower doesn’t do this, the entire transaction is cancelled, so that no funds were ever borrowed.
As a result, Aave doesn’t take a risk and neither does the borrower.
A borrower may wish to use a flash loan to take advantage of trading opportunities or maximize profits from other systems built on Ethereum. It’s possible to swap different cryptocurrencies in an automatic way using flash loans to generate trading profits.
Why Aave?
Although it often makes more sense to buy or sell cryptocurrency, borrowing it can be practical in some circumstances. One of the most obvious is for arbitrage. If you see a token trading at different rates on different exchanges, you can make money by buying it at one place and selling it at another.
Enter Aave and its Pool-to-Peer Lending platform. Users deposit digital assets into "liquidity pools." These become funds that the protocol can then lend out. Anyone who deposits their tokens into a pool and thereby "provides liquidity," receives new aTokens. (The "a" is for "Aave.") So, if you deposit Tether to the liquidity pool, you'll receive aUSDT in return.
As an aUSDT holder, you'll get a share of the platform's flash loan profits as well as interest on those aUSDT tokens. The amount that you make is based on how much liquidity is in each liquidity pool. The more that Aave needs a particular token to lend, the higher the yield will be. The same applies to borrowers—interest rates vary depending on what is being borrowed.
Aave Growth
In March 2022, Aave launched v3 of the protocol, which includes a feature called Portal. Portal allows Aave to operate seamlessly across numerous blockchains. That means using Aave, you can now participate in lending or borrowing protocols on chains like Solana or Avalanche, opening up DeFi opportunities across multiple ecosystems.
Additionally, Aave announced in July 2022, Aave's community approved a proposal to launch the network's own stablecoin, GHO. 99.9% of voters backed the proposal, which will see GHO launch as an overcollateralized stablecoin pegged to the U.S. dollar and backed by a "diversified set of crypto-assets."
The move means Aave users and borrowers will be allowed to mint GHO against their supplied collaterals while earning interest on the underlying, similar to how other borrowed transactions function.
Unlike algorithmic stablecoins, whose designs have been called into question following the collapse of Terra, crypto-backed stablecoins are assets collateralized by a basket of other digital assets.
Yet like its algorithmic cousin, GHO will be created by users when they supply the required collateral. When a user repays a borrow position, the GHO protocol governing the stablecoin burns that user’s GHO, according to the initial proposal on July 8.
Aave has positioned itself very well through the current bear market, continuing to earn fees as one of the highest earning platforms currently in the space, earning an average of 503K USD per day over the last 7 days as of the time of writing.