Aave

‣

Some History of Aave

In 2017, there was a team of developers who created ETHLend, an MVP platform that matched lenders with borrowers

Two big problems they’ve faced:

Liquidity in the system
Matching borrowers to lenders

In 2020, they made changes and turned ETHLand into Aave, pivoting the product

‣

What is Aave?

Decentralized Liquidity Market Protocol
A decentralized lending system that uses smart contracts to enable users to:

Lend
Borrow
Earn Interest

All on crypto assets without the need of middlemen

Peer-2-Smart Contract lending accessible to anyone using cryptocurrencies
Aave uses an algorithm to determine lending rates and to match the lenders with borrowers

‣

How does Aave work?

Aave has lending pools that enables people to lend or borrow different types of currencies like ETH, BAT, and more

‣

Lenders would deposit funds into liquidity pools in return for interest

Lenders, or Depositors, provide liquidity to the protocol
Depositing in liquidity pools creates what is known as a liquidity market
Lenders send their tokens to a smart contract on the Ethereum blockchain, and in return, they receive aTokens + interest

aTokens are pegged to the value of another asset (Ex: DAI vs aDAI)
This token would be encoded in order for lenders to receive interests on their deposits (determined by ratio between what is supplied vs borrowed within the token)

‣

Borrowers pay interest on the amount they borrowed (provided by lenders) in order for a sum of money immediately

Supplied tokens provided by lenders can now be used by borrowers

‣

Borrowers have to supply collateral in order to borrow other tokens

Ex: I put up collateral in DAI and borrow in ETH

The borrower now has exposure to different cryptocurrencies without owning them

💰

Collateral: An item of value that a lender can take away from a borrower if he or she fails to repay the loan (according to agreed terms) Ex: Banks usually ask to provide your home as collateral. If you fail to repay under the terms, that means that the bank has rights to take ownership of your home.

‣

All standard loans in Aave are overcollateralised, meaning the valued of supplied collateral has to be higher than the amount borrowed

Ex: Providing ETH in exchange for DAI, where value of ETH>DAI
This protects the protocol from being undercollateralised and not being able to repay depositors

‣

If the borrower becomes undercollateralised, they face liquidation

If liquidation threshold is met, borrowers face liquidation
Meaning if the loan were defaulted, the collateral would not cover the principal (failure to fulfill the payment of the loan)

Arbitrageurs now have a chance to buy the asset at a discount rate and pay the borrower minus a liquidation penalty
Arbitrageurs can then sell the asset on the open market and profit from the price difference

‣

Aave’s Flexible Interest Rates

For Aave, borrowers can choose between two interest rates:

Variable: Based on the usage of the liquidity pool (offer and demand)
Stable: Calculated from the average of the last 30 days

Fixed in the short term, but can change long term to accommodate changes supply/demand ratio between tokens

You can switch between variable and stable rates anytime through your dashboard

‣

Why would you want to take a loan when you have to supply tokens worth more than the actual amount of the loan taken and borrowed?

Some reasons include:

Users don’t want to sell their tokens, but need funds to cover unexpected expenses
Avoiding or delaying paying capital gains taxes on their tokens
Using borrowed funds to increase their leverage in a certain position

‣

Can I borrow without depositing?

No, you must deposit funds first before unlocking borrowing power
After depositing your assets, you can start trying other Aave features, such as:

Borrow other tokens depending on your collateral.
Use Flash Loan.
Swap your deposited assets.
Swap/repay your collateral assets.

‣

Is there a limit on how much can be borrowed?

Two main factors

How much funds are available to be borrowed in a particular market?
What is the Loan-to-Value (LTV) Ratio of the supplied tokens?

💰

The Loan to Value (LTV) ratio: defines the maximum amount of currency that can be borrowed with a specific collateral.

Ex: having a LTV of 75% means up to 75% of the token can be used to borrow other tokens

Ex: I put up $100 of Ethereum
the LTV Ratio is 80%
The maximum amount I can borrow is $80 of another coin like Tether

‣

Is there a limit on how long a user can borrow funds?

If a user borrows funds, the value of the borrowed amount must always stay lower than the value of their collateral x collateral factor

Borrowed amount < Collateral x Collateral Factor (LTV)

If this condition holds, there isn’t a limit on how long a user can borrow funds for

Basically, it’s as long as your position is safe, you can borrow for as long as you’d like

If the value of the collateral falls below the collateral level, the user would have their collateral liquidated in order for the protocol to repay the amount to lenders

As time passes, accrued interest will grow making the health of the loan decrease, making more likely for your loan to be liquidated

‣

When would there be liquidation?

Liquidation: A process that occurs when a borrower's health factor goes below 1 due to their collateral value not properly covering their loan/debt value.
This might happen when the collateral decreases in value or the borrowed debt increases in value against each other. This collateral vs loan value ratio is shown in the health factor.
Having your account liquidated is very bad since you lose your collateral to liquidators receiving liquidation bonus

‣

Examples

Example 1 Bob deposits 10 ETH and borrows 5 ETH worth of DAI. If Bob’s Health Factor drops below 1 his loan will be eligible for liquidation. A liquidator can repay up to 50% of a single borrowed amount = 2.5 ETH worth of DAI. In return, the liquidator can claim a single collateral which is ETH (5% bonus). The liquidator claims 2.5 + 0.125 ETH for repaying 2.5 ETH worth of DAI.
Example 2 Bob deposits 5 ETH and 4 ETH worth of YFI, and borrows 5 ETH worth of DAI If Bob’s Health Factor drops below 1 his loan will be eligible for liquidation. A liquidator can repay up to 50% of a single borrowed amount = 2.5 ETH worth of DAI. In return, the liquidator can claim a single collateral, as the liquidation bonus is higher for YFI (15%) than ETH (5%) the liquidator chooses to claim YFI. The liquidator claims 2.5 + 0.375 ETH worth of YFI for repaying 2.5 ETH worth of DAI.

‣

How is the interest on what the lenders receive and borrowers paid determined?

It’s determined by the ratio between he supplied and borrowed tokens in the particular market

The interest paid by borrowers is the interest earned by lenders, therefore the borrower APY is higher then the supply APY in a particular market

Interest APYs are calculated per Ethereum block. This can change dramatically depending on lending and borrowing demand

‣

Aave’s Flash Loans

‣

The process works like this:

A borrower requests funds in the form of a flash loan.
They instantly use the funds to take advantage of an arbitrage opportunity between two decentralized exchanges.
Once the transaction is complete, the flash loan is returned to Aave with the additional 0.09% charge.
The borrower keeps whatever profits were accumulated from the arbitrage.

Users can borrow funds without any upfront collateral for a short period of time
The catch is you must pay the flash loan back in the same Ethereum transaction you bought it with
Can be up to millions of dollars borrowed
Must be paid back in the same cryptocurrency block that it was borrowed in

‣

Why would you want a loan that you would have to pay back almost immediately? What’s the purpose?

‣

Trading Arbitrage

Ex: If you bought BAT at Binance for $1,000,000 and sold it on Coinbase for $1,100,000, you would make $1,000,000 profit

Be aware that you do have to pay fees (Aave is 0.09%)

Easier Ex: If you bought an apple from your mom for $1 and sold it to your dad for $2, you would easily double your money

‣

Collateral Swap

Users can exchange current collateral assets for other assets, making it easier for users to manage their risks and avoid getting liquidated.
Collateral, deposited before borrowing funds, can now be swapped for another cryptocurrency inside Aave.
Essentially you can change out your collateral without touching the initial amount of money you borrowed
When locking up cryptocurrencies as collateral there is a risk that the asset can devalue in price. If this occurs, a user could swap their cryptocurrency into a stablecoin to avoid price fluctuations.
Ex: Users collateralize ETH to borrow DAI. For some reason, they know that ETH price will decrease. Users transfer all ETH to YFI, and YFI then has good news so that the price increases. Therefore, users both avoid liquidation and can borrow more DAI due to the increase in YFI price.

‣

Self-Liquidation

Example:

If you deposited 100 ETH into Aave and it was worth $200 each ($20k total), giving you interest over time
At the time, you needed money. So you took a loan worth $16k worth of Tether (stablecoin) to pay bills, of which you spent it all
Fast-forward and now 1 ETH = $2,000, so you now how $200k worth of ETH locked up as collateral from your deposit
To get immediate access to it, you take out a flash loan worth $16k of Tether to repay your loan and get access to your initial 100 ETH
You would then use that initial 100 ETH, convert it to Tether, and use it to repay back your original loan
Now you have withdrawn $184,000 ETH (fees included) without putting any of your own money upfront, essentially liquidating yourself

An innovative approach made possible by the DeFi space, flash loans come with risks. Flash loans have been used in the past to attack the lending protocols that issue them.

‣

Aave’s Native token (AAVE)

The AAVE cryptocurrency offers holders several advantages.

AAVE borrowers don’t get charged a fee if they take out loans denominated in the token

Borrowers who use AAVE as collateral get a discount on fees as well

AAVE owners can further look at loans before they are released to the general public if they pay a fee in AAVE. Borrowers who post AAVE as collateral can also borrow slightly more

AAVE holders get to vote on changes to application as time goes on

‣

Aavenomics

The Aavenomics is a formalized path to the decentralization and autonomy of the Aave Protocol
The migration to AAVE marks the first step in transitioning governance power from the Aave core team to AAVE token holders.

‣

How to use Aave

https://youtu.be/IDzdrM4xjYw

‣

Versions of Aave

‣

Aave V1:

Brought to market innovations like Flash Loans and aTokens as new ways to unlock previously locked capital in DeFi and provide a permissionless savings account

‣

Aave V2: