History and the Aave project

What is Aave?

Aave, originally named ETHLend, is an open source liquidity protocol to enable interest on deposits and to borrow assets. It is one of the first DeFi projects to enable lending and borrowing on crypto assets in a decentralized manner. This lending system relies on the Ethereum protocol through a series of smart contracts.

History of Aave

Stani Kulechov founede the Aave company in November 2017 together with a team of developers in London. The company later acquired an office in Switzerland as well. Kulechov was studying law in Helsinki when he created Aave, which means “ghost” in Finnish. A symbol of the company and likely a reference to the protocol’s ability to make loans safely and anonymously. Initially, through an Initial Coin Offering (ICO) he launched ETHLend and the company managed to sell 1 billion LEND tokens and made 17 million dollars. The idea was to allow users to post loan requests and offers in a decentralised marketplace and then lend and borrow cryptocurrencies to each other. 

ETHLend matched lender and borrower with a peer-to-peer system but the system was too slow due to low liquidity and too much time spent matching borrowers and lenders, so progressively ETHLend was losing momentum. During the bear market of 2018 and 2019, the ETHLend team reworked the design, relaunching Aave in early 2020. In a podcast, Kulechov explained that the bear market was one of the best times ETHLend could have gone through. As it provided the team with the opportunity to revamp the concept of decentralized crypto loans, creating Aave. In 2018, the first peer-to-contract protocol appeared, allowing borrowers and lenders to interact directly with a smart contract. In 2020 the official launch of the version implementing the transition from the LEND to the Aave token took place. Holders of LEND tokens had the opportunity to convert them into Aave tokens.

How does Aave works?

  • Aave is an algorithmic money market, it releases loans on a peer-to-contract instead of peer-to-peer. 
  • The system is able to offer loans to borrowers through its liquidity pools. Users, i.e. liquidity providers or LPs, make available cryptocurrencies deposit in Liquidity pools. 
  • The goal of those who play the role of LP in these Aave pools is to gain benefits. This happens through the interest that is generated every time their cryptocurrencies are borrowed. In addition, it is also possible to use the pools within Uniswap. The goal of this bridge with Uniswap is to bring Uniswap’s liquidity as collateral for Aave loans. The interest rate charged to users depends on the utilization rate of the assets in a pool. If almost all of the assets in a pool are in use, the interest rate will be high to convince liquidity providers to deposit more capital. If few assets in a pool are used, the interest rate charged is low to incentivize loan applications. Then an algorithm defines the prices taking into account the supply and demand for the assets. An idea very similar to the one we can see in Uniswap (both in fact belong to the category of automated money markets). 
  • Aave allows users to borrow in a cryptocurrency other than the one they deposited while getting a regular return.
  • As with ETHLend, also in Aave all loans are extra-collateralized. I.e. if a user wants to borrow $100 in cryptocurrency through Aave, they have to deposit more than that amount.
  • Due to the volatility of cryptocurrencies, Aave incorporates a settlement process. If the collateral you provide falls below the protocol collateralization ratio, the system may liquidate your collateral. Additionally, there si a fee in the event of liquidation. 
  • Another important element of Aave is the decentralised governance of the protocol. In fact, token holders can intervene in the process and evolution of the protocol by voting to include enhancements within the system. 
  • Aave also allows for unsecured flash loans whereby you can borrow an asset. Provided that the amount borrowed (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 is possible thanks to the operation of smart contracts. Basically what happens is that a loan is scheduled, where we ask for 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 performed by the smart contract we are programming. In short, during the execution of the smart contract that we enter into, we ask for the loan and pay it off, taking the entire execution process of that smart contract as an interim time. 
  • Thus, the goal of AAVE is to create an algorithmic lending marketplace where users can do two things: invest money in pools to create liquidity (this will allow them to offer loans to other users and earn interest in the form of liquidity providers) and create a platform that can offer loans with various guarantees, collateralization options and operating policies. This is in order to adapt to the needs of its users and different markets.

Conclusions

Decentralized money markets like Aave pave the way for a more open and accessible financial system, and Aave is one of the biggest DeFi projects that allows crypto users to access funds and services transparently and quickly. One of its main advantages is definitely the simplicity of its use at the user level. In fact, since its inception, this protocol is one of the most immediate to use within the DeFi space.

Aave security is also one of the most studied within the DeFi ecosystem. As one of the first protocols in the ecosystem, its continuous improvement and the study of its smart contracts make it one of the most secure protocols. Definitely, Aave right now represents one of the most useful and reliable crypto protocols. We may consider it as the flagship cryptocurrency of DeFi in recent months with a desirable growth of its value in the near future.