Brief Summary
AAVE is the native governance token of the Aave protocol. Holders of this Ethereum-based cryptocurrency can discuss and vote on proposals that will influence the direction of the project.
As Aave is one of the leading protocols in decentralized finance, the AAVE token is also one of the largest DeFi coins by market cap. Ethereum investors can borrow and lend cryptocurrencies easily and decentralized through Aave.
Entrance
The tools that individuals use to lend or borrow their assets are of great importance to all modern financial systems. While borrowing increases the amount of capital a person can use when engaging in various activities, lending allows one to obtain a regular and reliable income from capital that would otherwise sit idle.
Cryptocurrency developers realized the need for such services and introduced money markets. Aave is one of the largest and most successful of these marketplaces.
Aave nedir?
Aave is an Ethereum-based money market where users can borrow and lend many different digital assets, from stablecoins to altcoins. Governance of the Aave protocol is in the hands of AAVE owners.
It can be difficult to understand what an AAVE token is without understanding the underlying Aave protocol. Therefore, let's first examine the protocol in detail.
ETHLend
Aave's roots date back to 2017. Stani Kulechov and a team of developers launched ETHLend with an Initial Coin Offering (ICO) in November 2017. The underlying idea is to make it possible for users to borrow and lend cryptocurrencies between each other by allowing them to post loan requests and offers.
While ETHLend is an original idea, interest in the platform and its token, LEND, declined with the onset of the 2018 bear market. The main problems with the platform are low liquidity and difficulty in matching loan demands and supplies.
Therefore, the ETHLend team revised the product during the 2018 and 2019 bull markets and launched Aave at the beginning of 2020.
Kulechov said in a podcast that this bear market was the best thing that ever happened to ETHLend. He said this because he and his team seized an opportunity to innovate the concept of decentralized cryptocurrency lending so that they could build the platform we know today as Aave.
How does Aave work?
The new and improved Aave is similar in concept to ETHLend. Both allow Ethereum users to take out cryptocurrency loans or earn returns by lending their savings. But these platforms are fundamentally different from each other.
Aave is an algorithmic money market. In other words, instead of matching individual lenders and borrowers, loans are taken from a pool.
The interest rate charged depends on the "usage rate" of the assets in the pool. If almost all of the assets in the pool are used, interest rates rise to induce liquidity providers to invest more capital. On the other hand, if virtually no assets in a pool are used, low interest rates are charged to encourage borrowing.
Aave also allows users to get loans with cryptocurrencies other than the ones they deposited. For example, a user can deposit Ethereum (ETH) and then withdraw from stablecoins to deposit into Yearn.finance (YFI) to earn a regular income.
Similar to ETHLend, here too all loans are over-collateralized. This means that if you want to borrow 100 USD worth of cryptocurrency through Aave, you will need to deposit more than this amount.
Aave has a liquidation process due to volatility in cryptocurrencies. If the collateral you offer falls below the collateralization rate determined by the protocol, your collateral may be liquidated. It should also be noted that in case of liquidation, an extra fee must be paid. It is important to make sure you understand the risks of depositing funds with Aave before submitting your deposit.
Other important features
Aave expands its scope beyond money markets. The platform has gained popularity as a place where DeFi users can get flash loans.
Often there is much more liquidity in Aave's money market pools than is available to borrowers. Those who take out flash loans, which are uncollateralized loans valid only for the duration of one Ethereum block, can benefit from this untapped liquidity.
At its most basic, a flash loan allows users to borrow large amounts of cryptocurrency without posting collateral and then repay the loan within the same transaction (as long as they pay the single-block interest rate).
This allows people without large amounts of capital to arbitrage and take advantage of other opportunities – all within the span of a single blockchain transaction. For example, if you notice that Ethereum is trading at 500 USDC on Uniswap and 505 USDC on another decentralized exchange, you can try to arbitrage that price difference by borrowing a large amount of USDC and making swing trades.
Apart from flash loans and other features, Aave is also working on a unique token (NFT) game called Aavegotchi.
AAVE Token
Even though ETHLend was renamed Aave, the LEND token continued to exist. This created a problem because LEND did not have the appropriate code to work the way the Aave team wanted. The problem is that LEND holders cannot control the direction in which the Aave protocol moves.
Although Aave is collecting more and more liquidity, users do not have the right to make changes to the protocol due to this issue. Later, a proposal was put forward for LEND to switch to a new token called AAVE, with 100 LEND corresponding to one AAVE.
As a new Ethereum-based ERC-20 token, AAVE has many new uses.
Primarily, AAVE holders act as support for the protocol. The introduction of AAVE also introduces a new concept called “Security Module”, which protects the system from lack of capital. This means that if the protocol does not have enough capital to cover lenders' funds, the AAVEs in the Security Module will be sold to replace the missing assets.
For this capital shortfall, only the AAVEs invested in the module are liquidated. Investing funds in this module is incentivized by a regular return paid in AAVE.
The second use case for AAVE relates to the governance of the Aave protocol. Holders of this cryptocurrency can discuss and vote on Aave Improvement Suggestions. Only proposals accepted by exceeding a certain AAVE token lower limit will be implemented. These proposals include changing the parameters of Aave's money market, as well as the management of funds in the ecosystem reserve. Similar to many other governance tokens, one AAVE is equivalent to one vote.
AAVE further decentralizes DeFi implementation and adds significant security support to the ecosystem against black swan events.
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Aave's challenges
One challenge for Aave is that all loans are over-collateralized. Unlike traditional financial systems, there is no credit scoring system or a procedure for systematically determining whether a borrower can repay his or her loan with interest.
This means that, unlike traditional loans where banks grant a low formal guarantee, on Aave users can only get a loan by locking up a much higher value of cryptocurrency than they requested.
These types of limitations make Aave a capital inefficient system. Aave requires users who want to get a loan to provide high amounts of capital, which makes it difficult for small users. Although the aim here is to protect lenders, this system limits the size of the total loan that can be taken out from Aave.
final thoughts
Decentralized money markets like Aave and Compound have paved the way for a more open and accessible financial system. Aave is an interesting project that allows users to access funds and services transparently.
AAVE token is also a promising development. It allows token holders to influence changes to the Aave protocol. It also protects the protocol from black swan events.
