What is Aave and why should I care?
Aave is a decentralized lending system. Aave stands out from its competitors (MakerDAO, Compound, etc..) due to flash loans and stable interest rates.
DeFi continues to explode in popularity and Aave’s driving a lot of that growth, having recently taken the number two spot on the entire Defi market from Compound as of this week. More specifically, what that means is that now, the leading projects hold more than $2.5 billion of the market’s $3.46 billion in value.
So, knowing the ins and outs of Maker, Aave and Compound currently leads to knowing where DeFi is heading, for the most part. Since I’ve discussed the other two in past posts, here and here, it’s Aave’s turn to go under the microscope.
What is Aave and where does it come from?
Aave was originally a project called EthLend that launched in 2017 with the aim of introducing fee-less lending on the Ethereum blockchain. In 2019, the project’s team decided to pivot to being Aave, which followed the introduction of the Aave protocol.
All in all, the key reason for the shift seems to have been the introduction of “flash loans” or loans that have to be repaid within the same block of being purchased and require no collateral at all, across their system.
Why is Aave useful?: Flash Loans and Stable Rates
For those of you who are new to cryptocurrencies, the first quality of flash loans definitely calls for a bit more explaining. If you know the Ethereum network, then you know that blocks are added to its blockchain every 13 seconds. Since Aave depends on an Ethereum DApp, in which its protocol lives, then this time applies to its flash loans as well.
Hearing that, you might think that flash loans are impossible to use since mere seconds are allocated to settle them.
After conversing with one of Aave’s team members, Marc Zeller, I discovered that there’s another, better way to understand flash loans.
Instead of trying to think of a loan being bought and used in 13 seconds, think of the buying and using of a loan as just happening in one transaction.
Who needs flash loans?
If flash loans have you scratching your head thus far, don’t worry.
Instead, consider trading algorithms or trading bots. If you’re not familiar with either of these things, just picture a computer program that allows you to perform a series of trading actions in a matter of moments. With that in mind, the most obvious use case for flash loans as they are today is for high-frequency traders or those that have such bots/algorithms that can purchase a loan, use it for trading and repay it, all within one transaction, reliably.
Other use cases exist, which I hope to discuss down the road.
Still, it’s important to point out now that in considering the average crypto user, it isn’t easy to think of a reason why they might find it necessary to take out a flash loan. Judging by the apparent fact that Aave was reportedly created more for the technically inclined, this makes sense with the project’s history.
Over time, I plan to examine flash loans further as my research continues and report here on my findings but for now, consider them as extremely useful for agile traders who need to move between positions in different cryptocurrencies quickly.
Are flash loans the only type of loan that Aave offers?
No.
Like all decentralized lending systems(Maker, Compound, etc..), Aave offers over-collateralized loans as well, which you may remember from my last post on Maker. Generally, an over-collateralized loan is one for which you have to deposit more funds than you take out. In Maker’s case, this is typically 150% of the loan amount you want, while in Aave’s, it varies based on the particular cryptocurrency you want your loan to be denominated in.
Aave determines each of these cases using a metric called the LTV(the Loan-to-Value Ratio). Generally, this ratio indicates the same thing as Maker’s which I mentioned above. For example, if you want to take out a loan in DAI, the LTV is currently 75%, which means that your loan can only be as high as 75% of the collateral that you deposit in advance. Here, it’s important to note that collateral is measured in Ether, which you can see on this page.
Currently, almost $13 million in DAI have been loaned out at this rate.
Stable Interest Rates
As I’ve said in the past, decentralized lending dominates the DeFi space and why shouldn’t it? It’s a way for anyone to earn passive income and secure the activity of a protocol and its respective DApp/s at the same time.
Generally, systems like Aave are like money market accounts or savings accounts on the blockchain. You don’t have to be a borrower but if you deposit your currency into one of Aave’s pools, then you’re a lender, earning interest for your troubles.
While, historically, most decentralized lending systems use variable interest rates for both borrowers and lenders that move based on community votes and overall transactional activity, Aave also offers stable interest rates.
This doesn’t mean that these rates never change, but simply that they change less often than the historically more popular variable rates. To understand how this plays out, you can track the activity on the Aave lending system here without making a transaction.
In a basic sense, Aave’s stable rates aren’t entirely stable. They’re just a better version of the variable rates, in the sense that they move less as activity in Aave’s lending markets rises and falls. According to one report, Aave’s stable rates could move when borrowing interest rates drop below deposit interest rates.
All interest to lenders is paid via aTokens, which is Aave’s native token that gives both lenders and borrowers interest on their deposits. Once either party is done participating in the system, they can send their aTokens back in exchange for their original funds.
What is the $LEND token?
If you’ve read anything about Aave, then you’ve probably seen its LEND token. Right now, all that LEND is used for is to minimize trading fees for borrowers and lenders. In other words, the more you hold, the lower your trading fees are.
What’s down the road for Aave?
The Aave team will soon introduce a proposal for how its native $Lend will be used as a governance token. If you’re not familiar with the term, just imagine every single coin as representing a vote and you’re well on your way.
This makes it possible for those with “skin in the game” (LEND users) to directly decide the future of the system they’ve invested in through proposing changes and voting on them. As the details of this shift in LEND’s usage are released, I hope to report on them in my next post on Aave.
Until then, as always, if you like my content, let me know here or on Twitter.
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Disclaimer: I own a very small amount of Aave, which I purchased after reviewing the project. None of this or any information in any of my other posts is meant to convince you to purchase a particular cryptocurrency. Always do your own research before making a crypto purchase.
