What is AAVE?
AAVE is one of DeFis closest protocols to a Bank. A money market system to enable non-custodial borrowing & lending. The project’s token is called $AAVE, which rewards users in staking rewards and governance on its protocol.
AAVE is one of the most well-known and established DeFi crypto protocols on the market. When you think lending, you tend to think AAVE. They, as a project, have contributed towards innovation in their products and constantly are looking to expand.
How Does Aave work?
In a traditional borrowing and lending system — within a Bank, a lender is matched with a borrower. The Bank acts as the intermediate, managing this. However, on AAVE, the protocol enables automatic, automated loans via smart contracts, which cuts out this middleman.
For AAVE process works by Lenders depositing their crypto into liquidity pools. These Liquidity Pools are pools of funds that enable depositors to earn interest based on their deposit, which will be lent out of the Liquidity Pools.
Anyone who deposits their tokens into a pool and thereby “provides liquidity” receives new aTokens. (The “a” is for “Aave.”) For example, if you deposit DAI to the liquidity pool, you’ll receive aDAI in return.
As an aToken holder, you’ll get a cut of the platform’s flash loans as well as interest on those aTokens.
Borrowers pay the interest rate. This, however, depends on the availability of assets in a liquidity pool. Meaning the rates fluctuate in accordance to meet demand and supply levels. Higher interest rates are used to incentivize lenders to deposit more & at a lower rate, the supply of assets is high.
In the traditional banking system, loans granted are under collateralized. However, with AAVE, the loans are typically over collateralized, meaning users need to deposit collateral higher in value than the amount they borrow.
Collateral represents something pledged as security; in the case here, crypto is held until repayment of a loan, in case of default. It is implemented across the Crypto market because it is volatile.
So, AAVE takes precautions to employ a liquidation process if the collateral value falls under the collateralization amount.
Flash Loans are not just a Flash in the pan
Volume still continues to grow, source Dune Analytics, @austin.
What are Flash loans?
AAVE was the first DeFi protocol to implement a type of loan, called a “flash loan,” these are loans that are instantly issued and settled. There is no required upfront collateral for these loans, and they happen almostimmediately; essentially, they are rapid-fire loans.
Users take advantage of this feature on Blockchains and issue loans within the time period when a new bundle of transactions are finalized; these happen within each block, which is then accepted by the network.
On Ethereum, this would be within 13 seconds as this is its block time. So, on AAVE utilizing a flash loan would mean it takes place with a 13-second period.
Not a flash in the pan
Total Flash loans are almost at 10 billion USD in value.
How Flash Loans Work
A borrower can request funds from AAVE, receive the funds, then deploy the funds borrowed in a transaction, then repay the loan all with the same block, part of a single-block multistep transaction. Users must pay back those funds, and a fee of 0.09% is typically charged within the same block. If the borrower doesn’t do this, the entire transaction is cancelled so that no funds were ever borrowed.
AAVE doesn’t take on risks, and neither does the borrower.
Why would you use a Flash Loan?
Flash loans enable the swapping of different cryptocurrencies automatically to generate trading profits. So, borrowers use a flash loan to take advantage of trading opportunities and lots of potential future applications.
They are currently used for:
- Arbitrage (programmatically exploiting price inefficiencies between various DEXs within single blocks)
- Collateral swaps (replace collateral in underlying loans without repaying the loan)
- Self-liquidations (can be thought of as DeFi refinancing without triggering taxable events),
There’s good, but there is also the bad
There is no question that Flash loans have a high level of demand, however as Flash loans are still a very new technology, they still are vulnerable to being used for malice — used in the past on hack style attacks on lending systems on Ethereum, in some cases stealing hundreds of thousands to millions of dollars in crypto.
AAVEs shift from V1 to V2
AAVE upgraded in 2020
December from V1 to V2 and its adoption really took off. V1 is still active and currently holds around $164 million USD amount, but V2 has presently 10 billion +. Some of the listed upgrades to V2 are listed below.
- The gas efficiency and high optimization of transaction costs.
- Debt tokenization. The debt from borrowers is now represented in tokens.
- Flash Loan V2. Aave updated the Flash Loan feature with various add-ons: Collateral Trading,
- Collateral Repayment, Margin Trading, Debt Swap, and Margin Deposits.
- Collateral Trading: By using Flash Loans, users can swap their collateral.
- Collateral Repayment: Users can swap one or multiple assets deposited in the protocol to use them to repay he debt entirely or partly.
- Credit Delegation: Aave allows delegators (depositors) to deposit funds in the protocol while delegating their credit to other users. This enables the lenders to earn extra yield and the borrowers to open undercollateralized loans. This is usually seen in institutions where there is a steadfast belief between the two parties.
Expansion Efforts
Source Aave Website
AAVE continues to grow not just in TVL but also cross-chain. AAVE is available across multiple chains and will look to expand in the future. In addition to Ethereum, it’s also on Polygon and Avalanche. Two other Ethereum Virtual Machine compatible chains. This could suggest transmission on to even more EVM compatible chains in the future. If so, it could contribute to the growth in the demand for AAVE its tokens and broader use of the dApp itself.
AAVE has been a big success on other chains, so it’s likely there AAVE will be looking at becoming even more multi chain.
On AVAX, it’s been a huge success, currently stacking the highest TVL figures — Which typically indicates demand/interest for the protocol. This is also the same on Polygon -AAVE also represents the most extensive TVL protocol on there too.
Source: The Block
TVL, although it isn’t perfect, is typically an indication of interest in a protocol; users are willing to deposit their assets into a project and have conviction in doing so. This could represent a metric for overall interest in a protocol.
NOTABLE ACTIVE CONTRIBUTORS
AAVE has some of the best and most well-known investors in the space that helped fund it from its infancy. These investors are now stakeholders and hold a considerable stake in active participation in the protocol.
Typically, it’s a positive indication if established crypto native firms have invested, as these players will have serious resources and vetting procedures from legal background to the resources in looking into a project's potential, which can be one of the contributing indicators of a good project. Helping an investor or lister with an added reason is confident.
On top of that, the integration, some of the Stakeholders below injects confidence to AAVE as they are trusted by the ecosystem.
STAKEHOLDERS & APPs
Source AaveWebsite
Tokenomics
AAVE Docs
AAVE DOCS
The token is $AAVE is an ERC20 Token with A total of 16,000,000 AAVE issued. 13,000,000 AAVE was distributed to users, while the remaining 3,000,000 AAVE was allocated to the ecosystem’s reserve.
Main use cases:
- Governance. AAVE can be used in AIP (AAVE Improvement Proposals) creation and approval. This goes towards to the Ecosystem Reserve to bootstrap the protocol, Governance of AAVE Markets, Safety Incentives.
- Staking in Safety Module to act as insurance. (Securing the protocol & Receiving incentives)
AAVE Docs
Governance
In what is described as multilevel governance, driven by incentives. The protocol itself uses a decentralized autonomous organization (DAO) called Aave DAO.
In the past, only the Aave development team could submit proposals. Until an updated version of the governance was activated in December 2020
The AAVE tokens provide a means to distribute voting power to Aave users. As a user, you can participate in the governance process of this project by holding AAVE tokens and/or stkAAVE (staked AAVE). Holders who stake the coin get to participate in the operating decisions of the platform in the form of on-chain governance.
AAVE users also have dual voting rights allocated to each token holder. All token holders can delegate their voting and proposing rights separately. In other words, if an AAVE holder delegates his proposing right to another community member, he can still exercise his voting rights once the proposal is up for deliberation.
Process of Submitting a Proposal for Governance
- Aave Request for Comments (ARC) on the community’s forum.
- Aave Improvement Proposal (AIP) The AIP can then be published and submitted via Github by forking
- the AIP repository. Once reviewed, the proposal will be enabled for on-chain governance.
- Obtain the required voting threshold whereby an AIP must garner a more substantial volume of positive votes before it can be implemented.
Staking
It is a method to secure the protocol $AAVE token holders are incentivized to lock tokens into a Smart Contract-based component called the Safety Module (SM) and can earn a yield of ~7% in return.
AAVE holders will deposit their tokens into the SM. In return, they will receive a tokenized position that can be freely moved within the underlying network.
In exchange, their staked $AAVE tokens could be slashed up in the event of a liquidity crisis / severe deficit for the protocol.
These could be triggered by Smart contract risk, Liquidation risk, Oracle failure risk. Metrics & Data
Distribution of the Asset 80% to the users, 20% to the team.Fully Diluted Valuation $2,525,997,362 Total Value Locked (TVL) $12,817,928,126
Fully Diluted Valuation / TVL Ratio 0.2
Market Cap / TVL Ratio 0.17
There are a total of 16M $AAVE tokens, of which 13,522,398 currently, with the remaining owned by the founding team.
Data From Coin Gecko
Has Second-Highest TVL in lending Sector / Source: The Block Source: The Block
Loans & Deposits have fallen significantly from their peak levels.
Possible Reasons:
- Unattractive yield, user deposits have greater gain yield elsewhere
- Demand for other chains that AAVE is not built on yet. So, end up using alternatives.
Source: Dune Analytics @datanuf
Loan-to-Value (LTV) is a ratio of a loan to the value of the collateral. It is the measurement of the balance of the loan relative to the value of the collateral asset.
Loan to value rates falling
Source: Dune Analytics @datanuf
- Loans are now higher proportionally to the collateral, around 33–36% in recent weeks. Compared to 10–16% a year before.
This can be a sign of:
- Value of collateral decreases due to bearish conditions and in the proportion of the loan. The price of crypto assets fluctuates; when the price moves up, the Loan-to-Value goes down. When the price moves down, the Loan-to-Value goes up.
- Users have more confidence in borrowing more significant amounts from AAVE (broader acceptance and trust in AAVE), So are want a higher percentage for loans.
Team
Source: AAVE Website
AAVE’s edge is not just the fact it innovates, but it’s a fact the team is experienced enough to push this innovation. Its team is very experienced in not just crypto but also Traditional Finance and the Technology world.
Key points of Strength for AAVE
- Established, blue-chip DeFi Project with a strong reputation
- Strong team with experience across crypto and Trad-Fi, and Technology.
- In regards to security, AAVE is one of the most audited and now regulated platforms; audits have been done by Trial of Bits, Open Zeppelin Diligence, CertiK, PeckShield, Certora and SigmaPrime. AAVE offers active bug bounties, and its procedures and management make it less is list than other coins.
- Unique UK banking license is a real advantage over some of its rivals. AAVE founder revealed the team is building a mobile wallet — this together with its banking license puts it in direct competition with Fin-Techs like Revolut & Coinbase. This will help onboard even more users not just to AAVE but also to DeFi, driving it all more mainstream.
- Innovative products: Two Notable developments in the future will create hype for AAVE and more demand as the protocol looks to move into new industry Big events that will drive sentiment and adoption. These items are Decentralized social media platform or Social Graph’ called Lens Protocol Ventures, once live will contribute which gain the project more traction to the interest of the project and likely causes more users to want to invest in AAVE.
- High TVL to Price. TVL has been gradually increasing faster than demand for the asset. An indication that users are more interested in using the project for its function instead of being influenced by its price. As it’s common to see TVL growth with price growth, this unsuitable metric if viewed in this light and should be taken with a pinch of salt. You would want to see the change that isn’t reliant on the asset’s price.
Token Terminal
Systemic & Protocol risks
According to DeFI Pulse, to quell safety concerns, it has had one of the most Smart contract audits in the whole of crypto, with around 13 Smart contract audits. These Audits dive read through the codebase to see if any potential issues or bugs would leave it vulnerable. GCC approval would be a positive reason for it to be accepted.
On the other hand, Flash loans could pose a risk in terms of exploitation by bad actors. It is worth considering the Risk considering if it would like to list their negative implications, for trust between a client and user.
It is also Potential for AAVE to have a liquidity crisis. Which would pose risk not yet scene in Crypto.
Crypto & Regulation & KYC & AML
In regard to AML or privacy concerns, there is always some level of risk in crypto due to the vast scope of the market being unregulated. However, recently AAVE launched its regulation-compliant DeFi platform
A DeFi first Offering in AAVE Arc, a permissioned lending and liquidity service to help institutions participate in regulation-compliant DeFi. This first Decentralized offering is a way to entice institutional participants to have regulatory compliance in DeFi.
Notable Partnership with the likes of Fireblocks boosts confidence as it’s an institutional digital asset custodian.
The new pool enables whitelisted institutions to participate in DeFi as liquidity suppliers and borrowers.
Users of Aave Arc must perform due diligence procedures such as knowing your customer/ anti-money laundering (KYC/AML) to gain access.
Fireblocks also serve as a whitelisting agent for Aave Arc, ensuring other institutions that wish to join the permission pool perform KYC/AML requirements.
Securitize, a technology provider for issuing tokenized securities, is bringing its identity verification system to decentralized finance (DeFi). It is also regulated by the Securities and Exchange Commission (SEC) and a holder of US broker-dealer and alternative trading system (ATS) licenses, proposing its know-your-customer (KYC) solution to DeFi lending platform Aave.
Actions for larger Institutional clients getting involved?
Become an LP, a lender, or even a borrower on AAVE Arc. Active participation in the protocol could mean better rates on loans or staking interest rewards and relationships being built for the future, meaning access to new initiatives they are working on, keeping an institution ahead of its competition.
Ownership of some AAVE tokens to vote in the governance help grow and expand the protocol for the better long term.
Final Remarks
Aave is one of the most well-managed crypto projects.
Aave is constantly innovating, keeping it one step ahead of its competition, shown by rising TVL when the price has gone sideways.
Innovation is good because, over time, firms tend to lose their moat, and the same will apply to Crypto protocols. Innovating helps to increase a user’s moat but also diversifies. This is precisely what AAVE is doing with its mobile app, Social Media Initiative and AAVE Arc.
Decentralized governance is run well, with active community and forums. This transparency provides a good overview of how the protocol is managed and how it responds to its user base and combines this with incentives with its userbase.
The only security concern would be the possible abuse of flash loans and the face liquidity crisis that could occur if the protocols’ structure is not correctly managed.