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DeFi Deep Dive: Aave

Aave is a decentralized lending system that allows users to borrow, lend, and earn interest on crypto assets without the need for a middleman. Aave operates on the Ethereum blockchain and uses a system of smart contracts that enables the assets on the platform to be managed by a distributed network of computers running its software. Because of this, their users don’t have to trust a certain institution or individual to handle their money.

The Aave software currently allows users to create lending pools enabling them to lend or borrow on over 20 different cryptocurrencies. In order to borrow funds on Aave the user must post collateral, and can borrow up to the value of the collateral that they post while risking liquidation if market conditions turn for the worse soon after issuance. Aave also has additional features, such as flash loans, and other forms of debt and credit issuance but these are currently in the alpha stage in terms of user adoption and usage.

Currently as of September 6th, it sits as the #35 Cryptocurrency with a market cap of $5.3 billion and resides at #7 in all of DeFi. Only trailing other giants such as Uniswap, Chainlink, Terra, and Pancakeswap. The price of $AAVE is at $404.28 with an all time high on May 18th, 2021 at $631.26.

History

Aave is a Finnish word meaning “Ghost” and was originally known as ETHLend back when it launched in November of 2017. ETHLend was a peer-to-peer lending system. While working on ETHLend substantially throughout 2018, the Aave team realized peer-to-peer lending came with a lot of inefficiencies and decided to move away from it. Aave, as it’s known today, switched to a peer-to-contract lending platform in 2018 and has been doing that ever since.

The founder and CEO of Aave is Stani Kulechov who is the main public face of the company. Stani was studying law at the University of Helsinki when he found out about Ethereum and its capabilities. He began exploring how it could impact the TeFi system, and came up with Aave’s previous name ETHLend.

Capital/Funding

In 2017 Aave launched an ICO (Initial Coin Offering) which raised them $16.2 million in capital. The ICO gave Stani the ability to hire more developers to focus on improving the protocol.

In January 2020 Aave went live on ETH Mainnet, supporting 16 assets. In July of 2020 Aave received a $3 million investment from Three Arrows Capital, Framework Ventures, and Parafi Capital. Since then, Aave has been funded by Blockchain Capital, DTC Capital, Standard Crypto, Blockchain.com Ventures, and Defiance Capital.

2020 was the defining year for Aave, their TVL surged from $300,000 to around $2 billion by the end of the year. Aave token ($AAVE) was also the best performing asset of 2020 and yielded gains of 5,000%. Currently, Aave has about $18 billion in total value locked.

What Does it Do?

Aave is a system of lending pools that enables users the option to borrow, lend, and earn interest on 20 different digital assets without the need for a middleman.

Users who want to earn interest on their money will deposit funds that they want to lend, which are then collected into a liquidity pool. When a borrower takes out a loan, they draw from those pools. Lenders can trade or transfer these tokens in any way they see fit.

Aave issues two types of tokens to facilitate this activity, $AAVE (native token)and aTokens.

The $AAVE token is used in several ways:

  • If a user uses $AAVE as collateral for borrowing, they get discounted fees, and $AAVE borrowers don’t get charged a fee if they take out loans denominated in the token.
  • Owners of $AAVE have the option to look at loans before they are released to the public if they pay a fee.
  • Users who use $AAVE as collateral can borrow slightly more than if you were to use any other digital asset. Nomics has a more extensive list of things a holder can do.
  • Token holders can stake $AAVE on the platform to receive roughly 6% APY on their allocation.

aTokens:

  • These tokens are minted upon deposit and burned when redeemed.
  • They are pegged at a 1:1 ratio to the value of the underlying asset deposited to Aave protocol.
  • aTokens provide lenders a “receipt” that allows them to collect interest on their deposits.

In December 2020 Aave upgraded its platform to Aave V2. The upgrade brought the ability to repay a portion of the loan collateral without having to conduct several transactions, allowing users to save on network fees (up to 50% less on ETH transaction fees), time, and effort by combining these operations into one transaction.

In addition, borrowers on the Aave platform are now issued a token, like aTokens for lenders. The token lets borrowers manage their borrowed tokens from their cold wallets. The update also brought stable borrowing rates and fixed interest rates that provided better predictability and impermanent loss avoidance from market volatility. Support.token provides a more detailed list of V2 upgrades.

Tokenomics (Aavenomics)

In July of 2020 Aave founder and CEO Stani Kulechov announced the protocol’s tokenomics, “Aavenomics”. The Aavenomics upgrade converted every 100 $LEND tokens into 1 $AAVE token, with a maximum total supply of 16 million. The upgrade had a governance vote and was passed with almost 100% unanimity. With the new vote, 13 million of the 16 million tokens were redeemed by $LEND holders and the remaining 3 million went into the Aave ecosystem reserve which is described as a “bootstrap fund allocated to protocol incentives as governance saw fit”.

Furthermore, the Safety Module was launched along with the token rebasing. The Safety Module acted as a staking mechanism for tokens to act as an insurance in the case of shortfall events. This brought token farming for $AAVE in which stakers could earn safety incentives and a percentage of protocol fees.

In 4 months from the Aavenomics launch (October 2020), $AAVE was trading at a massive premium of around $50. In the beginning of 2020, $LEND was priced at $0.02. Even with the supply cut and the rebalanced price of $2, AAVE was up 2,400% in just 4 months.

The whole reason for the Aavenomics launch was to make Aave more decentralized through governance from token holders. A direct quote from their published documentation, “The goal of the Aave Tokenomics, through its incentives and policies, is to create a Shelling Point where the protocol’s growth, sustainability and safety take priority over individual stakeholder objectives”.

Security Concerns/Audits

According to Token Sniffer, Aave contains a proxy contract, which carries the possibility of protocol exploitation. A proxy contract lets developers change things to blockchain protocols, it’s how Aave V2 was able to be implemented. Just like how Facebook finds bugs and provides updates to fix them, proxy contracts allow developers to update “immutable” blockchain protocols when issues are found. The issue with proxy contracts is that in theory, a hacker could change or manipulate a protocol in their favor (to steal funds for example) by using and exploiting the proxy contracts deployed for that specific protocol.

Having a proxy contract brings a slight vulnerability to Aave, but it also brings flexibility and the option to make the protocol better based on governance voting from token holders.

To mitigate the risk with proxy contracts and other forms of hacking potentialities, Aave has a bug bounty campaign, where anyone can try to exploit their protocol to find vulnerabilities. If they find a vulnerability, the user gets a monetary reward based on how critical the vulnerability found is, it ranges from $100 to $250,000. Aave is also continually being audited by various audit platforms:

Roadmap, Progress, and Sentiment

Aave’s momentum from 2020 carried itself into 2021. To kickstart 2021, Aave successfully launched its V1 -> V2 migration tool. Users are able to transfer their liquidity positions from version 1 to version 2 almost seamlessly, powered by flash loans. Flash loans are a way to borrow a digital asset with no collateral needed. You can click the embedded hyperlink for more information on them. On March 16, 2021 Aave released its first ever AMM (Automated Market Makers) market. The AMM Liquidity Pool allows liquidity providers from Uniswap and Balancer to use their LP (liquidity provider) tokens as collateral in the Aave Protocol.

In 2021 Aave is narrowing its focus on scalability and exploring “New Frontiers”. Aave’s multi-market approach allows it to dive into these new frontiers. Building synergies with other projects is one of the main assets that DeFi has. Aave is taking advantage of this by building markets in all of the places that matter in Crypto. Their most recent example of new frontier scalability is the Sidechains with Polygon implementation. This implementation brings extremely fast and almost free transactions onto Aave. Additionally, Polygon is powered by Chainlink which brought Aave flagship safety in protocol price feeds. Polygon being synergistic with Aave allows for more collateral options to be fit into the networks which adds scalability to both Aave and Polygon.

As of writing this, the Polygon Sidechains integration is the last big thing that Aave has done. So far, there is no more announcement of what’s to come other than scalability and trying to mitigate ETH price fees which is their main focus in 2021.

The Bottom Line

Aave is a flagship product in the Ethereum ecosystem, and is setting standards for other peer-to-contract lending protocols to follow. With its explosiveness in the last year and 8 months we can only hope they carry their energy to continue to define new frontiers in the DeFi space. Aave is such a big player in DeFi that Grayscale has been looking at Aave for their next trusts, showing how much trust and momentum they have gained.

The last alluring tweet at the time of writing, by founder and CEO Kulechov, is a meeting with someone in the metaverse space. One can only imagine what could come out of that as Aave looks to continue growing into bigger and better things. See you all in the Metaverse.

About RF Capital

RF Capital is an alternative investment firm with a special focus in the underlying infrastructure of the blockchain space. Other areas of specialization include real estate, debt/equity markets, and OTC trading.

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R.F. Capital

R.F. Capital

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Cryptocurrency investment firm focused on projects and tokens fundamental to the network and infrastructure of the entire sector.