What is Aave? It is a popular DeFi lending protocol and a token. This is a beginner’s and guide to Aave. We’ll go through Aave’s history, technology, and potential as an investment.
Aave is a DeFi token
Let’s begin by placing Aave into the correct category. We like to divide the cryptocurrencyncy market into three main categories: currencies, platforms, and tokens.
The best-known currency is Bitcoin. This category also includes coins such as Litecoin, Bitcoin Cash, and Monero. They are all built as P2P digital currencies and have no other significant features. Even if Bitcoin’s narrative has shifted towards digital gold, it fits this category.
Ethereum is the king of the platform category. These cryptocurrencies are also called frameworks and operating systems for distributed apps. You can think of platforms like iOS or Android. Cardano, Binance Smart Chain, and Polkadot are rivaling platforms.
Tokens are issued on these platforms. This is the category of Aave as well. Tokens are usually either utility tokens or governance tokens. They serve a role inside a specific application.
We can also go deeper into the token category and select a sub-category called DeFi (Decentralized Finance). Almost all DeFi tokens are governance tokens. Other popular DeFi tokens include Uniswap, Compound, and Maker.
The word Aave is Finnish and means a ghost. This is the only well-known project with Finnish background. The word Aave can refer to the app or its native token, which has a ticker AAVE.
Note, that this is not a user guide for the Aave app. This article is an overview of the Aave protocol for potential investors.
Aave was originally ETHLend
The founder of Aave is Stani Kulechov, who doesn’t have a typical developer background. Stani has a master’s degree in law from the University of Helsinki. He has also worked in a lawyer’s office.
In the beginning, there was just a handful of people involved. Aave was not launched by famous Silicon Valley VCs. Now there are dozens of people working on the project and the headquarters are located in London. Stani is still the CEO and the spokesperson of Aave.
Aave started as a project called ETHLend. It was launched on Ethereum MainNet in early 2017. ETHLend was also part of the ICO boom of 2017. The project collected 16,2 million USD from its ICO. This is when the LEND token was also created.
See the video below if you want a “blast from the past”. It shows how ETHLend worked.
ETHLend was a P2P loan service and one of the first DeFi protocols in the market. It was developed further in 2018, but the team realized quickly that P2P lending was a difficult concept to use. It was hard to match different lending and borrowing needs.
In 2018, other DeFi protocols started to emerge. The whole scene was still very much unknown, and even the word “DeFi” was barely used.
This was the time when Uniswap DEX was developed as well. It used a P2C (Peer-To-Contract) model. In a P2C model, a liquidity pool is created by the lenders instead of everyone trying to find a borrower individually.
ETHLend adopted the P2C model in late 2018. This is also when the protocol was re-branded to Aave. The LEND token was still used, though.
If you want to learn more about the project’s history and development, see the video below.
The year 2019 was quiet on the DeFi front. Even at the beginning of 2020, the liquidity pool of Aave had less than 10 million USD of funds. Fast forward to June 2020, and this number was already 100 million dollars!
The entire DeFi market exploded in the summer of 2020. The liquidity of Aave kept multiplying too and reached 1,5 billion dollars. In Jan-Feb 2021 there was another DeFi boom. The liquidity of Aave grew from 1,7 billion to 6 billion dollars.
At the time of writing this article (4/2021), Aave is one of the most popular DeFi protocols with about 7 billion USD liquidity. The biggest competitors in the loan sector are Compound and Maker.
The picture below is taken from defillama.com.
The old LEND token was also re-branded (migrated) to AAVE at the end of 2020. While this was done, the supply was cut by 100. A hundred (100) LEND tokens were converted into one (1) AAVE. This was part of a series of updates called Aavenomics.
Both LEND and AAVE have been excellent investments. The price of LEND went 40x in 2020, from about 0,01$ to 0,4$. Then it was migrated to AAVE with a price of 40$. AAVE rocketed more than 10x in early 2021 as well.
There have been several updates to the AAVE protocol. The most significant one was the launch of AAVE V2 in December 2020. You can read more about that from the Aave blog.
Overview of DeFi
Aave is a lending protocol, which is part of DeFi meaning decentralized financial services. Let’s have a quick overview of DeFi.
In short, DeFi is all about decentralized applications built on cryptocurrency platforms. Such apps are called Dapps (Decentralized Apps). They run autonomously without any third-party interaction. Users are communicating with Dapps using Web 3 wallets like MetaMask.
DeFi used to be a synonym for Ethereum. This changed rapidly in 2021. There are popular DeFi apps running also on Binance Smart Chain and Polygon. In total, there are about 10 platforms with more than 100 million USD value locked in DeFi apps.
Below is a screenshot of PancakeSwap. It is a popular decentralized exchange running on Binance Smart Chain.
We are broadly talking about a financial revolution. DeFi brings financial services to anyone in the world who has a mobile phone and an internet connection. There is no KYC or other limitations. These kind of services have never existed before.
DeFi can be divided into three sub-categories: lending services, decentralized exchanges, and others. The biggest apps in terms of TVL (Total Value Locked) are lending services. Aave has been one of the biggest DeFi applications since 2020.
What is Aave?
Let’s dive into the Aave protocol. How does it actually work? Since Aave is a lending service, it offers two main functions:
- Interest payments
As mentioned in the history chapter, Aave uses liquidity pools. This means there are investors, who deposit funds into the Aave protocol. This liquidity pool is then accessed by people who want to leverage their crypto holdings with a loan. Loan takers also pay interest to liquidity providers (= lenders).
The picture below is from Aave.com. It shows different interest rates being paid at the moment.
In this case, you could deposit DAI stablecoins and get paid 2.35% APY. People borrowing these coins would pay 3.56% APY. Both rates can change a lot even in one day based on supply and demand. Sometimes these rates have been 10x higher.
Once you have made a deposit to Aave, you can also use it as collateral and take a loan. This way you can leverage your portfolio and use the loan to buy more cryptocurrencies. You just have to earn more money than the interest being paid.
You should note that the native token Aave is not needed. All transaction fees are paid in ETH since this application is running on Ethereum.
Aave Safety Module, flash loan, and government
There are other features too in Aave besides the standard lending & borrowing.
Let’s start with flash loans, which were popularized by Aave. These are essentially super fast loans enabling large amounts of liquidity to be used. This is possible because flash loans are taken and repaid inside one Ethereum network transaction.
See the video below for detailed instructions.
Flash loans are made by creating a process, which consists of several operations chained together. If one of the operations fails, the whole process is reversed.
Flash loans create efficiency for the entire DeFi market. Trading bots can take advantage of arbitrage situations and make prices more precise.
Aave Safety Module and governance are part of the Aavenomics framework. This was launched in late 2020. Aavenomics describes in practice, how the Aave protocol is governed.
The Safety Module was launch with the AAVE token in late 2020. Aave users can loan funds into this module and earn interest. If something unexpected happens and the protocol runs into liquidity problems, the Safety Module will use a maximum of 30% of these funds to cover any losses.
Aave governance is where the AAVE token is needed. Token holders make decisions about the future of the protocol. Improvement proposals are made by the community or the development team. The more AAVE tokens you hold, the more voting power you have.
You can dig deeper into the governance at governance.aave.com.
This is the concept used by other DeFi protocols as well. DeFi tokens are almost exclusively governance tokens.
Aave as an investment
There is no doubt that Aave has been an excellent investment so far. The DeFi boom of 2020 alone gave thousands of percentages of gains for Aave investors. But, how should a new investor look at this protocol? What kind of potential does Aave have as an investment?
First, you must remember Aave is a governance token. We covered this topic in the previous chapter. Many newbies think that Aave is used in the protocol to pay interest, qualify for loans, etc. This is not the case.
A utility token is easier to evaluate. Once the application grows, there are more transactions, which leads to a higher demand of the utility token. Staking generates also a constant demand for many tokens, such as ETH, BNB, ADA, MATIC, etc.
Governance tokens are different. There is no direct link between increasing liquidity (popularity) and the token price.
Check the video below for further views on Aave.
Many investors are making the connection between liquidity and token price. In theory, this should be the case. One would think the governance token gained value in parallel with the growth of iquidity. However, this is not the case in practice.
The market cap of the Aave token is higher than the market cap of its rivals, which have more liquidity. This is because there are other factors in place. For example, the popularity of decentralized exchanges is better described by the trading volume.
The biggest driver of Aave token price is the growth of the entire industry. Aave made its biggest gains in the summer of 2020 and Jan-Feb of 2021 when the whole DeFi market was booming.
Is Aave a better investment than Compound or Maker? This question is difficult to answer.
Aave has one advantage over its competitors. The development company received UK’s Electronic Institution license in 2020. This is the same license held by Coinbase and Revolut. It makes it possible to build a fiat on-ramp to Aave protocol!
If you are interested in Aave, check also Aavegotchi (GHST).
Aave is not only competing against decentralized loan protocols. There are also centralized loan services, such as Celsius Network and BlockFi. Centralized services have their own fans. They are easier to use and provide customer service in case of errors.
One of the main issues of Aave has been Ethereum. The platform has been clogged since early 2020 and might not get better until version 2.0 is running. In fact, DeFi apps are mostly to blame for the congested network.
Transaction costs have exploded, which has driven small investors out of Aave. Every single Ethereum app has had the same issue.
This situation is solved with Layer 2 solutions. Polygon is the most popular one. Aave has already created a Polygon version of the app too. About half a billion dollars of liquidity was moved to the Polygon version in just one day.
TVL metrics are lame, but reaching half a billy in L2 in 24 hours with more users than L1 is freaking aavesome pic.twitter.com/PUM2VtF3Rz
— stani.lens (🌿,👻) (@StaniKulechov) April 15, 2021
To put it simply: Aave protocol can be copied from Ethereum blockchain to Polygon because Polygon is EVM (Ethereum Virtual Machine) compatible. EVM is the processor running all smart contracts.
Users can now choose if they want to use the app on Ethereum or Polygon. With Layer 2 scaling, transaction costs go practically to zero. This opens DeFi apps for small investors too.
Aave price and how to buy Aave
Aave is available in the most popular cryptocurrency exchanges. We recommend the market leader Binance. You can deposit using SEPA transfers or credit cards.
There is also strong support for Aave in popular wallets. TrustWallet (mobile) and Exodus (mobile & desktop) are great choices. MetaMask is a popular browser add-on. Ledger Nano X and Trezor Model T offer ultimate safety.
Follow Aave on Twitter at @AaveAave. You should also follow the founder, StaniKulechov, who is very active on Twitter. The official website is aave.com. There is also a Reddit community at reddit.com/r/Aave_Official/.