What is AAVE and how does it work?

7 min read

Aave is one of the oldest and best known DeFi projects or Decentralized Finance. Its original name was ETHLend and they were dedicated to lending with cryptocurrencies.

With the evolution of cryptocurrencies, the Aave platform has been forced to change some aspects of its operation. It is now much more than what it was before, a simple lending platform with cryptocurrencies.

History of AAVE

Both Aave and its previous name, ETHLend were founded by Stani Kulechov with the goal of increasing loan applications on Ethereum. Its creator, Kulechov is an entrepreneurial law school graduate who started in the programming world at a very young age. He was among the first to start with the blockchain space.

El proyecto fue construido antes de que existiera la financiación descentralizada y fue lanzado a la red a finales del año 2017 bajo su primer nombre, ETHLend. Posteriormente el CEO decidió cambiar el nombre de ETHLend a Aave, ya que la compañía había evolucionado y ofrecía nuevos servicios además del préstamo Ether.

After the launch of ETHLend, the project managed to raise in an ICO the total of $17 million thanks to which the platform went ahead and managed to release, at the end of 2017 its LEND token. The project began by making P2P loans among its users, thus creating a decentralized lending market. Its users were divided between those who wanted to borrow and those who lent their cryptocurrencies in exchange for interest.

Gradually it evolved into liquidity market-based lending where the price is calculated based on the availability of the assets. In Aave, whoever wants to receive a loan will have to put up collateral as a guarantee to ensure that there is no risk of default.

According to its creator, the Aave project has as its target market those users who already participate in the world of cryptocurrencies. This new project created from LEND creates a new market where the interest rate of a loan is defined through an algorithm between supply and demand at the second of making the loan of assets. Currently this concept is known as automated money market.


How does AAVE work?

Aave uses a very simple interface that has as its main objective to achieve an algorithmic lending marketplace where users can invest money in liquidity pools allowing them to make loans to other users and earn interest for being liquidity providers.

Another of the platform’s main objectives is to be able to offer collateralized lending and various operating options and policies to meet the needs of users in different markets.

To achieve these objectives, Aave uses a very simple operation. It is based on the formation of liquidity providers by investing in Aave’s pools. Thanks to this, for each new loan made on the platform, the liquidity provider will obtain a profit that will be added to the total profit of its investment.

On the other hand, users who need the loans only have to enter the platform and apply for it. Aave will ask you for collateral as a guarantee in exchange for the loan and that’s it. The operation is simple, you pledge your cryptoassets as collateral in exchange for a loan and once you repay the loan, you will be returned those cryptoassets.

These two functionalities are the essence of the Aave platform, offering decentralized lending in an easy and secure way.

What mechanisms does Aave use?

Among the main advantages of the platform’s operation are the lack of centralized intermediaries in the process, since only transparent smart contracts are interacted with. 

Another great advantage is that our cryptocurrencies are not sold or exchanged. When we repay the loan, we will get them back without risk of loss. These mechanisms put Aave ahead of the banks.

Liquidity Pools for loans

All this is just a small portion of all the benefits the platform offers. Liquidity pools form one of the most important parts of the ecosystem. These are a set of cryptocurrencies introduced into the protocol. These pools are formed by the platform users themselves.

Aave pools serve as an incentive for many more users to join aave to inject liquidity and thereby earn more profit by making loans. These pools represent cryptocurrencies such as MKR, DAI, USDC, Ethereum and many other cryptocurrencies in addition to the platform’s native token, LEND. In total the platform supports liquidity pools of 19 tokens in total.

Because of all these options, Aave has made its way into the current DeFi ecosystem and more and more users are showing interest in how the platform works. These pools not only aim to move money, but also to generate profits. These profits move in annual percentages ranging from 0.02% to 4.45%.


Interest rates on loans

Another of Aave’s functions is to offer interest rates that are adjusted to the users’ needs. The platform offers different types of interest rates and users can choose from these depending on which one best suits their loan. This feature has set Aave apart from other platforms in the lending industry and has allowed it to continue to climb the rungs of the ladder in the last year.

Loan security

Aave also offers a set of safeguards to deal with the constant volatility to which cryptocurrencies are subjected, preventing them from breaking the market dynamics within the platform. Most of these safeguards are found in Safety Module (SM) or the Aave Safety Module. The main function of this system is to watch that the proper functioning of the platform is not affected.

This security system includes the following areas:

  • The Staking module. This area is intended to protect the liquidity of the protocol in the event of a crash in the crypto markets.
  • The Backstop module. This system contains the previously deposited stablecoins and the ETH that occupies a priority position in the auction in case of a shortfall.
  • Auction module. This module is activated in case of a downturn by converting the blocked tokens to reduce losses to the minimum cost.
  • Ecosystem reserves. These have the function of covering losses within the platform.
  • Oracles. In last place we have the oracles in charge of finding immediate information about the market and from this information make decisions on the platform.