We have witnessed different types of protocols establishing their roots in the DeFi space. Many have succeeded and many have failed too. Certainly, among the success stories of the DeFi space, in particular the lending protocols, is the protocol called Aave. Users on the Aave platform can access the protocol freely to establish money markets. Aave along with several other lending protocols have turned into hotspots for users seeking decentralized markets.
It is worth noting that what we know as Aave today started as ETHlend; we will elaborate on this later in the article. However, since the platform was given a new facelift, it has gone on to become one of the famous DeFi protocols in the market ranking as high as 25 on Coinmarketcap (as of January 08, 2021). The platform offers several outstanding services, like interest rate switching, which we will be talking about later. Aave has its native token, which governs the protocol and helps it achieve full decentralization.
Understanding the Switch From Ethlend to Aave
Talking about the first DeFi lending platform then arguably, we can say that Aave holds that title. Although it was launched as ETHlend, it took off in 2017 and that is even preceding what we now know as DeFi. ETHlend was able to carry out a successful ICO to the tune of $16.2M in 2017 before setting up its London office the following year September, which will serve as the base for Aave. The team behind ETHlend moved over to Aave upon the successful establishment of the new company in London. However, ETHlend remained a part of Aave until January 2020 when it ceased operation.
Before ETHlend became Aave, the Founder Stani Kulechov and his team designed it to be a platform that brings lenders and borrowers together eliminating any intermediary between them in the process. They found mild success initially but then they decided on a slightly different strategy in a new space with the crypto industry, which is the booming DeFi sector.
So, with that enters Aave intending to plug the space left behind by fintech giants such as Netteller, PayPal, etc. To fulfill this goal, the team came up with the Aave protocol, which is to serve as a non-custodial and open-source platform for establishing money markets via the Ethereum network.
An Overview of the Aave Protocol – How It Works
We were introduced to the most significant part of the Aave protocol in January 2020 after the release of the Mainnet, which brought a very different protocol to what the users were used to with ETHlend. With the new features offered via the protocol, Aave was aiming to make a serious statement with their intent, and that they certainly did. This also signified their change of strategy from the previous P2P lending found on ETHlend to the new pool-based strategy that is the foundation of Aave.
This works by allowing Lenders/Investors to inject liquidity through cryptos. The liquidity is sent to the available lending pools where investors can earn interest on them. On the other hand, those interested in borrowing loans can do so by making use of any of the lending pools. Borrowers can either obtain loans in an undercollateralized or overcollateralized manner. There is no need for borrowers to be paired directly with lenders. It is as simple as lenders injecting funds into the lending pool and you getting instant loans depending on the state of the lending pool.
With Aave, you are getting loans in a decentralized way that doesn’t require a third party as well as KYC. To protect against any volatility, which we all know the crypto market for, a small part of the asset deposited into every lending pool is reserved for that purpose. At the same time, the reserved percentage enables lenders to cash out their money at any moment’s notice.
The Aave protocol supports up to 19 tokens, which are Ethereum, Ox Coin (ZRX), REN, SNK, Binance USD, DAI, USDT Coin, WBTC Coin, Augur, ChainLink, TrueUSD, sUSD, Yearn.Finance, Enjin Coin, Maker, Kyber Network, USD Coin, Decentraland, and Basic Attention Token.
Due to price volatility that is unique to each asset that means every asset has its collateral requirement. It is worth noting that none of the listed assets is eligible as collateral for a crypto loan. We talked earlier about overcollateralized loans which means that your collateral (in USD) that is locked has to surpass the amount you are withdrawing. Depending on the type of asset, the amount can fall between the ranges of 50% to 75%.
In the event that your collateral USD value drops below the required threshold for collateralization then the locked funds are made available for liquidation purposes. Others can then buy the funds at a lower rate on the protocol. To gather data about the assets’ price, Aave employs ChainLink to serve as its oracle. You can view the acquired interest in real-time as they accumulate every second.
The Types of Interest Rates
We have two types and they will be discussed below:
Stable interest rate – this stands for the average interest rates for each asset over 30 days. This can be viewed as you are borrowing or lending on the Aave protocol.
Variable Interest rates – this one is DeFined by the Algorithm using the rate of utilization or demand of each asset pool. That means that higher demand for a specific pool will cause the interest rate to rise for the borrowers and lenders while a lower demand will cause the interest rate to decrease.
You can effectively swap between variable and stable interest rates whenever you want for a little ETH gas price.
The Governance Token – From Lend to Aave
The protocol, when it was known as ETHlend, made use of LEND as its native token. This has carried on following the switch to Aave in January this year. Although it was called LEND on Aave initially it was very different from the previous LEND on ETHlend. The ERC-20 token serves various purposes among which are fee reductions for holders, voting, used as collateral, and much more.
However, in the bid to go fully autonomous and embrace decentralized governance. Aave swapped its LEND token for AAVE after handling over the protocol to genesis governance. The number of LEND tokens that are swapped for AAVE is around 1.3 billion, which is swapped at a ratio of 1:100. We have the total supply of AAVE at 16 million of which 3 million AAVE is sent to the new AAVE Reserve meant for improving the protocol following the community backing.
The community will get to vote on issues like protocol and market policies as presented in the Aave Improvement Proposals.
What happens when you deposit into the Aave protocol whether as a borrower in the form of collateral or as a lender in the form of liquidity? Well, you are given an equivalent amount of funds deposited in the form of aTokens. Basically, 200 ETH gets you 200 aTokens. The tokens allow you to get an interest on your funds. The APR interest rate of your deposit determines the percentage of aTokens that is sent to your ETH wallet as interest by each second. When you want to withdraw, you can then swap the token for the same amount of asset you deposited initially.
The Features of the Aave Protocol
Understanding Rate Switching
One of the unique features of the Aave protocol is rate switching. This feature enables borrowers to change from floating interest rate to fixed interest rate and vice versa. This can come in handy given the volatile nature of the crypto market. In the case of high-interest rates, borrowers mostly go for a fixed interest rate. However, if the market becomes volatile and the rate is projected to decrease. Users could change over to floating interest rates to lessen the costs of borrowing.
However, you can only change from a fixed rate if the earning rate on deposit rises past the fixed borrow rate. In the absence of that, instability can set in from disbursing more than the amount that is getting into the system. If that does occur then a new stable rate will be given by rebalancing the fixed rate. However, if the rate is 20% below the fixed rate then automatically the loan reduces to make up for the difference.
Explaining Flash Loans
Another feature that puts Aave in another league is the flash loans feature, which enables users to get loans that don’t need collateral. The flash loan is issued through a custom-made smart contract that allows you to borrow assets from the Reserve pools on the Aave protocol within a single transaction. The only condition for the loan is that you repay it before the end of the transaction.
Failure to do so on time will reverse the transaction and undo all activities carried out up to that point. Thus, securing the liquidity in the Aave reserve pools. The fee you pay on a flash loan is as low as 0.09% and the loan is targeted at those with technical knowledge such as developers.
Launching Aave 2.0
To enhance its capabilities and its market reach, Aave decided to roll out Aave 2.0 with many added features. This adds more flexibility and efficiency in managing funds to the platform. Of all the newly introduced features, the standout amongst them is the collateral swap feature and which is backed by the newly improved flash loan feature.
Let’s take it further when you borrow Aave using their crypto assets as collateral. In doing so, you are settling for a long position. That means you as a holder of ETH who wants to delve into other markets without losing your ETH. You can simply borrow DAI via MakerDAO and still retain your ETH, however, this gets you locked into the ETH position. You can’t change out of this position until you repay your debt.
However, with the new collateral swap from Aave 2.0, you can swap your underlying assets serving as collateral. This is done while still inside the Aave protocol in a manner that is gas price friendly and efficient. So, what we are saying here is if your initial collateral is WBTC, you can simply swap it for ETH. This will come good especially if your initial projection over the loan you took goes sideways in terms of the collateralized asset price. That is if your collateral begins to drop price due to volatility, you can simply swap it to avoid liquidation.
We can argue that the market already similar collateral swapping, however, it is not quite like Aave’s newly introduced swapping of collateral. The type we are used to requires many blocks, which can result in slippage as well as significantly high gas prices due to the need for a couple of applications to carry out the process. Aave’s version eliminates this bottleneck using flash loans, which requires that you obtain and pay back a loan within a single block on the Ethereum network. Version 2.0 will also bring additional features to the governance of the protocol.
Generally, the team aims to create a better version of Aave with each release. It doesn’t look like the team is stopping on 2.0, which makes it more exciting for users and investors alike.
👻It's the moment we've all been waiting for… Aave V2 is live on mainnet! 🍾🎊
Head over to https://t.co/gzkAogjUOS to try it out
Check out the Aavesome new features, security & audit details, and more in the latest blog post: https://t.co/N1oXXH4X5u
— Aave (@AaveAave) December 3, 2020
What Makes Aave a Good Investment?
We will look at the standouts about Aave that makes it worth the money apart from the fact that it has been performing considerably well in the market. One thing that stands to benefit users on the Aave protocol is its user-friendliness. The ease of use means people will be drawn to the protocol and when people interact more with a protocol it is bound to have an effect on its value across the market. Right from the time of ETHlend up to its switch to Aave, the protocol has maintained the simplicity of usage.
Then we can start to talk about the eye-catching interest rates that it offers for loans on its platform, which bodes well for borrowers. The protocol is even designed to allow lenders to earn even more for providing liquidity. As such, the protocol is highly rewarding for both lenders and borrowers. The introduction of Aave as its governance token has a role to play in boosting the value of the Aave token too.
Another thing that makes Aave good for its value is the ability to make a direct withdrawal in the form of Ethereum. You can do that also when you obtain flash loans. This is a value booster in an Ethereum-dominated world of DeFi.
Aave is one of the first DeFi protocol even before DeFi became hugely popular as we have it today. As such, the security of the protocol has been extensively developed and studied over time. This results in the continuous improvement of the protocol, which is evident with the recent launch of the Aave 2.0. The way its economic ecosystem is planned also ensures it is stable and operation remains undisturbed in the face of bad conditions in the market.
Aave Protocol v1 and v2 have surpassed $3B in combined market size! 🥳
— Aave (@AaveAave) January 6, 2021
The Aave protocol promises much with several features that users will find appealing. Aave had one of the largest total value locked during the 2020 DeFi hype. When talking about some of the biggest ethereum based DeFi protocols, Aave will definitely be among the top protocol in the market. The future also looks good with the team behind the protocol always looking to improve upon it and offer its users more exciting options.
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