What is Aave?
One of several emerging DeFi cryptocurrencies, Aave is a decentralized credit system that allows users to lend and borrow cryptoassets without an intermediary and earn interest.
Aave runs on the Ethereum blockchain and is instead a smart contract system that allows these assets to be managed from a distributed network of computers on which its software runs.
This means that Aave users do not need to trust a specific institution or person to manage their funds. They just need to trust that the code will run as written.
In essence, Aave software helps create credit pools that allow users to lend or borrow 17 different cryptocurrencies, including ETH, BAT, and MANA.
As in other decentralized credit systems on Ethereum, Aave borrowers must post collateral before they can borrow. In addition, they can only borrow up to the value of the guarantees they have posted.
Borrowers receive funds in the form of a special token, known as an aToken, which is tied to the value of another asset. This token is then encoded so that lenders receive interest on deposits.
For example, a borrower can post collateral in DAI and borrow in ETH. This allows a borrower to engage in different cryptocurrencies without owning them directly.
Aave may also introduce additional functions such as instant loans and other forms of debt and credit issuance that utilize the unique design properties of blockchains.
Who created Aave?
Aave is a for-profit company founded in 2017 by Stani Kulechov and based in Switzerland. Kulechov trained in law in Helsinki and founded Aave while still a student.
The company, which was originally called ETHLend, raised $16.2 million in an initial coin offering (ICO) in 2017 and sold 1 billion units of its AAVE cryptocurrency – initially called LEND – during this period.
The remaining 300 million units of the AAVE cryptocurrency were held for the Aave team.
ETHLend differed from Aave in that, instead of pooling funds, it sought to connect lenders and borrowers in a peer-to-peer manner. In 2018, ETHLend was renamed Aave, which means “spirit” in Finnish. ETHLend became a subsidiary of Aave.
Other products and services announced at the time included a trading desk for processing large transactions, a gaming studio focused on blockchain gaming, and a payment processing system.
How does Aave work?
Perhaps the best description of Aave is as a credit pool system.
Users deposit funds they wish to lend, which are then collected into a pool. Borrowers can then draw from these pools when taking out a loan. These tokens can be exchanged or transferred as the lender wishes.
To facilitate this activity, Aave issues two types of tokens: aToken, issued to lenders to allow them to collect interest on deposits, and AAVE-Token, Aave's native tokens.
The AAVE cryptocurrency offers several advantages to its holders. For example, AAVE borrowers are not charged when taking out loans denominated in this token. Additionally, borrowers who use AAVE as collateral receive a discount on fees.
AAVE holders can also view loans before they are made available to the general public if they pay a fee in AAVE. Borrowers who post AAVE as collateral can also borrow a little more.
Data company Nomics has a more comprehensive list of AAVE features.
Flash Loans
Aave allows for the immediate issuance and settlement of certain loans, called “flash loans”. These loans do not require prior collateral and are almost immediate.
Flash credits use a feature of all blockchains, which is that transactions are only completed when a new packet of transactions, called a block, is accepted by the network.
Adding each new block takes time. On Bitcoin, this interval is around 10 minutes. On Ethereum it is 13 seconds. An Aave-Flash loan therefore takes place during this 13-second period.
The flash loan works as follows: A borrower can request funds from Aave, but must repay those funds and a 0.09% fee in the same block. If the borrower fails to do so, the entire transaction is canceled, so the money was never loaned.
As a result, Aave takes no risk and neither does the borrower.
A borrower may wish to use flash credit to take advantage of trading opportunities or to maximize profits from other Ethereum-based systems. It is possible to automatically trade different cryptocurrencies with flash credits in order to make trading profits.
Note: Flash credits have been combined to launch attacks against Ethereum-based credit systems, sometimes managing to steal deposits worth hundreds of thousands of dollars.
Why is AAVE valuable?
AAVE plays a central role in managing the Aave software and allows users to vote on changes to their rules and policies.
The Aave team is working on a proposal outlining precisely how AAVE tokens will be used to control the system, which is expected to be released in mid-2020. An AAVE owner will, for example, be able to vote on the interest rates of certain loans and on certain aspects of deposit management.
Aside from these benefits, AAVE derives value from its limited supply and the fact that it uses fee revenue to purchase AAVE and remove the cryptocurrency from circulation.
Currently, 80% of the fees collected by the Aave system are used to burn AAVE. The rest is used for fee-paying lenders. Permanent burning of AAVE is expected to reduce its supply and therefore drive up the price of the token if demand remains constant.
Why invest in AAVE?
AAVE may be of interest to traders or investors who believe decentralized lending will continue to gain popularity.
As of July 2020, the Aave system will be one of the most active decentralized credit systems on Ethereum, with total deposits of US$158 million. Competing lending platforms include Compound and Maker, which have deposits of more than US$600 million.
You can also use AAVE if you want to participate in the rules of the Aave system and vote on how fees taken from loans are distributed to AAVE token holders.