AAVE, or formerly ETHLend, is a well-known decentralized finance project or DeFi that is focused on making loans with cryptocurrencies, using a simple interface and under a scheme that revolutionized this sector.
Uno of the projects DeFi or Decentralized Finance oldest is AAVE, formerly known as ETHLend. This is a platform that was originally dedicated to offering decentralized loans with guarantees in cryptocurrencies. But throughout its existence, AAVE has been subjected to the same evolutionary forces as the crypto world. A fact, which has led it to become much more than a simple crypto loan platform.
Now AAVE is a complete DeFi platform with multiple tools, which you will learn about below.
AAVE (ETHLend), the beginnings of DeFi on Ethereum
ETHLend was the name with which, in 2017, the AAVE project started. In fact, its launch responds to a successful ICO (Initial Coin Offering) that allowed them to raise 17 million dollars. With this financing, the project managed to move its platform forward and by the end of 2017, the LEND token, the heart of the platform, was launched.
The idea of the project was simple: create a decentralized loan market. On the one hand, there were those who wanted to borrow, and on the other, those who lent cryptocurrencies in exchange for interest. In AAVE, those who request loans have to put a guarantee collateral, to avoid defaults. A fairly flexible mechanism that caught the attention of many users.
In addition, the platform offered loans with different types of collateral. All this flexibility made ETHLend a widely used platform in the crypto world, especially by traders who were looking for loans that would serve to leverage their positions and obtain better profits.
In September 2018, the ETHLend developers decided to transform the platform by offering new services and thereby changed its name to AAVE. Furthermore, AAVE transformed its loan system to one based on liquidity markets, where prices are calculated based on the availability of assets in said market.
In simple words, prices within AAVE are defined algorithmically taking into account the demand and supply of assets. An idea very similar for example to the one we can see in Uniswap o Curves, with which he would share the same category of automated money markets (Automated Market Money or AMM).
Objectives of AAVE
The aim of AAVE is to create an algorithmic loan market where users can do two things:
Invest money in pools to create liquidity. This will allow them to offer loans to other users, and to earn interest in the form of liquidity providers.
Create a platform capable of offering loans with various collaterals, collateralization options and operating policies. This in order to adjust to the needs of its users and different markets.
The operation of these two options is simple. First of all, if you want to be a liquidity provider, all you have to do is invest your money in the pools within AAVE. In this way, with each new loan made by the platform you will obtain a small profit that will ultimately translate into the total profit of your investment.
On the other hand, if you are a user who wants a loan, all you have to do is interact with said platform. At this point, AAVE will ask for a guarantee in exchange for offering you the loan in question. Basically you pawn your crypto assets in exchange for the loan, once you return the loan, the platform will refund all of the crypto assets pawned.
These are the basic functionalities of AAVE, and at all times they have a clear objective: offer a secure and decentralized lending platform.
AAVE operating mechanisms
Now, how does AAVE accomplish all of this? What is the mechanism that allows your entire platform to function and be maintained? To see this in a simple way, let's imagine the following example:
Daniel wants to get a loan that allows him to make a small investment. Logically expect a good return on that investment. However, Daniel does not have enough money in his possession for the investment he wants to make, but he does have a house among his possessions, so he will use it as a mortgage guarantee to request a loan from the bank.
The bank at this point makes a valuation of the house, and agrees a value with Daniel. After that, the bank gives Daniel a loan under certain conditions of payment and interest. In this way, Daniel gets his money, makes the investment, and after X months he should have paid his loan and the interest, but he will also have obtained the investment earnings.
This type of example is quite simple to see, since we are used to the figure of the mortgage. In the case that concerns us, AAVE does precisely the same, it asks you as a user for a guarantee in the form of cryptocurrencies for which it offers you money (other cryptocurrencies) in the form of a loan. Said loan is under very clear conditions, where you must pay it in a certain period of time and with clear interests. Thus, when returning the loan, the platform obtains its profits and you can recover your cryptocurrencies without major problem.
The advantages of this are many but for now we will highlight two:
Throughout the process there have been no centralized intermediaries in the form of an opaque corporation, you only interact with a few smart contracts transparent and immutable.
At no time did you sell and buy cryptocurrencies, you simply pawned, so the taxation of it is very different and advantageous compared to a purchase / sale.
For this reason, AAVE is much better than a bank and the possibilities it offers you are much greater than those of any traditional financial institution can offer you. However, this simple example only superficially shows what AAVE does, as there is much more behind it. Let's learn more!
Pools of liquidity, agglutinating assets to make loans
AAVE is able to offer loans to those who require it thanks to its liquidity pools. The liquidity pools are a group of cryptocurrencies that are introduced to the protocol. They are created by users who want to put their cryptocurrencies there and, in return, they are called liquidity providers or LPs.
The objective of those who play the role of liquidity providers in these AAVE pools is to obtain benefits, through the interests that are generated each time their cryptocurrencies are borrowed.
This mechanism serves as an incentive for more and more people to want to inject liquidity, thereby offering higher loans and obtaining higher profits.
These pools at AAVE currently represent various cryptocurrencies. In fact, the protocol supports cryptocurrency pools such as DAI, USDC, TrueUSD, USDT, sUSD, BUSD, Ethereum, YFI, BAT, EnjinCoin, KNC, LINK, Mana, MKR, REP, ZRX, wBTC, SNX and AAVE's native token, LEND.
In short, a total of 19 different tokens supported that at the time of writing this article add up to a total of 1,8 trillion dollars in locked value. In other words, the different AAVE pools currently have a liquidity of 1,8 trillion dollars.
This gives us a clear idea of the level of economic relevance that AAVE has within the current DeFi ecosystem. And it also tells us one thing: there are many users who have shown great interest in the AAVE operating model.
Pools, of course, not only serve to make money, but also to offer profits. Pools offer liquid injectors an annual profit percentage ranging from 4,45% (for DAI) to 0.02% (for ZRX). Although these values are also adjusted according to the level of supply and demand within that pool and the total liquidity available within it. All this is managed by smart contracts that constantly monitor these parameters.
Variable and stable interest rates
Another of the most striking points of AAVE is its ability to offer interest rates adjusted to needs. AAVE offers its users two interest rate options (stable or variable) and you can freely choose between them. In this way, the user can at all times choose the best interest for their loans, seeking the best possible position.
Thanks to this function, AAVE has differentiated itself from other platforms in the sector and has also allowed great growth in this year 2020.
Security system for loans
AAVE being a loan protocol that uses cryptocurrency collateral, it also has a series of safeguards to prevent the volatility of the markets from breaking the positive dynamics of the system. Most of these safeguards fall on Safety Module (SM) o AAVE Security Module. Basically, it is a system that is responsible for monitoring the proper functioning of AAVE and all the subsystems attached to the protocol (such as the case of oracles).
The system is made up of the following areas:
Staking module: which is responsible for protecting the liquidity of the protocol in the midst of a fall in the cryptocurrency markets.
Auction module: which is activated in the middle of a market in deficit to reconvert the blocked tokens and keep losses to a minimum.
One Backstop Module: which contains the ETH and previously deposited stablecoins that have a priority position in the auction in the event of a deficit event.
Ecosystem reserve: with which losses can be covered within the protocol.
OraclesProvided by Chainlink and backed by AAVE, which are intended to provide first-hand information on market actions and from there the following decisions will be made within AAVE.
Thanks to this operating scheme, AAVE guarantees that in the midst of downward onslaught in the price of its pools' tokens, liquidity providers can always maintain a positive position with respect to their invested tokens.
Uniswap, within AAVE
AAVE has its own liquidity pools to offer loans to its users, but in addition to this it also offers one more possibility: use the pools within Uniswap. The goal of this bridge with Uniswap is to bring these Uniswap liquidity assets into the loan space as collateral for AAVE.
In this way, AAVE is able to present new pairs of loans, increase its level of liquidity and allow users of both platforms to interact.
Governance of the protocol
AAVE also has a governance model that seeks to take the protocol to a new level of development. The governance system proposed by its developers is supported by what they call AAVENOMICS.
AAVENOMICS is an entire economic policy that will support AAVE in its entirety. The main idea is to transform your current LEND token to the new AAVE token. This conversion will take place in a ratio of 100 LEND per 1 AAVE, and its objective is to reduce the current LEND token circulation, and revalue the AAVE token.
In this way, each AAVE token holder will have the potential not only to vote within the platform, but will also have a high value token that will have its point of origin in the production of incentives for users who live within the protocol. In total, 16 million AAVE tokens will exist, of the 13 million will be distributed among users and 3 million will be blocked in the reserve.
Along with this, AAVE seeks that its new token increases the participation of users in governance, and at the same time serves as a macro stabilizer throughout its economic system as it is a staking and trading tool within other protocols, such as Balancer.
The vision of this governance model is completely innovative, however, at the moment there is still no explicit paper on the complete operation of this system. It is expected that by 2021 this system will begin to be implemented with the migration process from the LEND token to the AAVE token.
How much do you know, cryptonuta?
Does the AAVE protocol allow you to carry out operations using your own pools and those of Uniswap?
One of the most striking features of AAVE is its ability to trade using its own pools and Uniswap pools. However, the Uniswap market is much more limited in options and liquidity, giving a clear signal that AAVE users prefer to use AAVE's own pools in their trades.
Flash loans, AAVE's star function
All of the above makes it clear that AAVE is a very complete protocol designed to present the best possible loan tools. However, there is a star function within AAVE that has catapulted it into the DeFi ecosystem: flash loans.
However What are flash loans? Well, a flash loan or flash loans is nothing more than an unsecured loan, in which you can borrow an asset, as long as the borrowed amount (and a fee) is repaid before the end of the transaction.
This is something totally new in the traditional financial world, but also in the blockchain world, and it is possible thanks to the operation of smart contracts and the way in which the Ethereum EVM works.
Basically what happens is that a loan is programmed, in which we request a certain amount of tokens of an asset supported by the platform. In return, we will make the payment of that loan within the same operation carried out by the smart contract that we are programming. In short, during the execution of the smart contract that we make, we request the loan and pay it, taking the entire execution process of that smart contract as intermediate time.
At this point (during the execution of the smart contract) is where we can schedule extra transactions inside or outside AAVE managing the amount borrowed. The important thing is that at the end of the execution of the smart contract, the borrowed money must be repaid together with the interest.
This is not a commonly used tool for AAVE users. The smart contract for a flash loan must be built from scratch and meet the requirements requested by AAVE for acceptance. Otherwise, it will not be executed. Despite this, flash loans have become a commonly used tool for many DeFi experts and advanced AAVE users.
One of the main advantages of AAVE is the simplicity of its use at the user level. In fact, from the very beginning, when they were ETHLend, this protocol has been recognized as one of the easiest to use within the DeFi space.
Another point in favor of this platform is that they offer very good interest rates for loans, but not so much as well as earnings for liquidity providers. In this sense, the platform is designed to be a high-volume loan platform that seeks to compensate for these two facets of the protocol.
Another additional point is the decentralized governance of the protocol. LEND token holders can intervene in the process and evolution of the protocol by voting to include improvements or modify values within the system. This speaks of a great openness within the system, one that we hope will maintain over time.
In addition, another interesting feature is that it allows you to withdraw your money directly in ETH, even when you make use of flash loans. This is very useful for interacting with other applications in the DeFi world of Ethereum.
Finally, AAVE security is one of the most studied within the DeFi ecosystem. Being one of the first protocols in the ecosystem, its continuous improvement and study of its smart contracts make it one of the safest protocols. In addition, its economic security also guarantees its stability and good operation even in the worst market conditions.
A negative point is the low interest provided by its pools, which makes this protocol less attractive for investors, especially those who implement the yield farming or liquidity mining. If you intend to put these conditions into practice at AAVE, you may not get much value for your money. However, AAVE can leverage your positions within other platforms (such as Compound or Yearn Finance), what is it that users of this platform usually do.
Flash loans can be a powerful tool with multiple functions, but at the same time, a high-level threat to these protocols. AAVE is one of the first protocols to implement these functions, and although at the moment accessing them is tedious, this window is still open to unknown security problems.