Summary

AAVE is the native governance token of the Aave protocol. Holders of the Ethereum-based digital currency can discuss and vote on proposals that influence the direction of the project.

Aave is a leader in decentralized financial protocols, and AAVE has naturally become one of the DeFi tokens with the highest market value. Through Aave, Ethereum investors can easily lend and borrow digital currencies in a decentralized manner.

Introduction

Media is the core of all modern financial ecosystems, and individuals need to borrow and borrow assets through the media. Borrowers can use borrowed funds to participate in investment activities, while asset holders can regularly obtain safe and stable returns by lending out otherwise idle funds.

Digital currency developers have recognized the need for such services and launched so-called "currency markets". Aave differentiated itself from competitors and gradually developed into one of the largest and most successful marketplaces.

What is Aave?

Aave is an Ethereum-based money market that supports users to borrow and lend various digital assets from stablecoins to altcoins. The Aave protocol is governed by AAVE holders.

It’s hard to understand what the AAVE token is without understanding the underlying Aave protocol, so let’s dig into it.

ETHLend

The origins of Aave can be traced back to 2017. In November 2017, Stani Kulechov led a development team to launch ETHLend in the form of an initial coin offering (ICO). The idea is to create a platform for issuing loan requests and offers to support users in issuing loan requests and offers for digital currency assets.

Although ETHLend is a trendy idea, the platform, along with its token LEND, suffered in the 2018 bear market. The main pain points with this platform are the lack of liquidity and difficulty in matching loan requests with offers.

Therefore, after experiencing the bear market in 2018 and 2019, the ETHLend team overhauled the product and launched Aave in early 2020.

Kulechov said in a podcast that the bear market may be one of the best development opportunities for ETHLend. During this period, he and his team members comprehensively revolutionized the concept of decentralized digital currency lending, and Aave came into being.

How does Aave work?

The new and improved Aave is conceptually similar to ETHLend. They all allow Ethereum users to obtain digital currency loans or obtain income returns by lending out their holdings. However, the two are quite different in nature.

Aave is an algorithmic money market, which means that loans are sourced from a pool of funds and are not matched to individual lenders.

The interest rate charged depends on the "utilization rate" of the assets in the pool. If the assets in the pool are almost fully operational, interest rates will be high, attracting liquidity providers to inject more funds. Conversely, if utilization is negligible, the interest rate charged drops, in turn attracting borrowers.

Aave also allows users to obtain loans in digital currencies that are different from their deposited assets. For example, a user can deposit Ethereum (ETH) and withdraw the stablecoin, then deposit it into Yearn.finance (YFI) to earn regular income.

Same as ETHLend, all loans are over-collateralized. This means that if you wish to borrow $100 worth of digital currency through Aave, you will need to deposit more than that amount as collateral.

Considering the volatility of digital currencies, Aave has set up a forced liquidation process. If the collateral provided is lower than the collateral ratio stipulated in the agreement, the position may be forced to be liquidated. Please note that there will be a fee for forced liquidation. Before submitting a deposit, it is important to understand the risks of depositing funds into Aave.

Other important functions

Aave's business is extending beyond the currency market. The platform provides flash loans for DeFi users, so it is very popular.

Generally speaking, the liquidity in Aave's money market pool is much higher than the loan requirements of borrowers. Unused liquidity is available to flash loan users. This is an unsecured loan that only exists for the span of one Ethereum block.

Fundamentally, flash loans allow users to borrow a large amount of digital currency without providing collateral and then repay the loan in the same transaction (as long as it pays single-block interest fees).

This way, people without large amounts of capital can conduct arbitrage trades and gain access to other opportunities—all within the same blockchain transaction. For example, if you find that Ethereum is trading at 500 USDC in Uniswap and at 505 USDC on another decentralized exchange, you can borrow a large amount of USDC and trade quickly, trying to arbitrage the difference.

In addition to flash loans and other features, Aave is also developing a non-fungible token (NFT) game called "Aavegotchi".

Exploring AAVE

Although ETHLend changed its name to Aave, its token LEND has not disappeared. This issue is of concern because LEND does not have the appropriate code to work the way the Aave team wants. In other words, LEND holders have no control over the development direction of the Aave protocol.

The reason for this problem is that Aave is getting more and more liquidity, but users cannot modify the protocol. To this end, it was proposed to exchange LEND for a new token "AAVE" at a ratio of 100:1.

As an ERC-20 token based on Ethereum, AAVE creates many new use cases.

First of all, AAVE holders will serve as a solid backing for the protocol. The launch of AAVE introduces a new concept called "security module" to protect the system from shortage of funds. This means that if there are insufficient funds in the protocol to cover the lender, the AAVEs in the security module will be sold in exchange for the assets needed to cover the shortfall.

Only AAVE deposited into this module will be forced to liquidate due to losses. As a bonus, depositing in this module earns you regular returns paid in AAVE.

The second key use case for AAVE involves the governance of the Aave protocol. Digital currency holders can discuss and vote on Aave improvement proposals. If approved with at least a certain number of AAVE tokens, the proposal will be implemented. This includes changing the parameters of the Aave currency market and managing funds in the ecosystem reserve. Like many other governance tokens, one AAVE equals one vote.  

AAVE deepens the decentralization of DeFi applications and becomes a solid backing for the development of the ecosystem, effectively reducing the impact of black swan events.

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Challenges faced by Aave

A major challenge faced by Aave is that all loans must be over-collateralized. Aave has not established a credit scoring system or program that is widely used in the traditional financial system, and cannot systematically evaluate whether the borrower can repay the loan with interest.

This means that, unlike traditional loans offered by banks, which require little formal collateral, Aave users must lock up digital currency worth far more than the loan they apply for.

This limitation means that Aave is a capital inefficient system. Aave requires users to invest a large amount of money to obtain loans, which is difficult for small-scale users to accept. Although this is to effectively protect the practical interests of creditors, the system will naturally limit Ave's total debt.

Summary

Decentralized currency markets such as Aave or Compound are building a more open and barrier-free The financial system paved the way. Aave is a very interesting DeFi project that allows digital currency users to use funds and services clearly and transparently.

The AAVE token also has great development prospects, and its holders have the right to influence changes in the Aave protocol. It also protects the protocol from black swan events.

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