What is AAVE: exploring the community-governed liquidity pool

Aave, formerly ETHLend, is a decentralized non-custodial borrowing and lending protocol that lets users deposit assets into liquidity pools to earn returns and borrow assets at a variable or fixed interest rate. It was launched in 2017 by Stani Kulechov, following a $17.8 million initial coin offering (ICO). Aave also allows users to take out uncollateralized, ultra-short duration loans known as flash loans.

The decentralized protocol manages debt by making sure that all loans (except flash loans) on its platform are over-collateralized, meaning the value of the collateral must be greater than the loan itself. If the value of a user's collateral falls below a certain threshold, the collateral is automatically liquidated to repay some of the debt. This ensures that there is always adequate liquidity in the system.

TL;DR

• Aave is a decentralized borrowing and lending decentralized finance (DeFi) protocol.

• It's the second-largest DeFi protocol in the world by Total Value Locked (TVL), according to DeFiLlama.

• Aave maintains liquidity on its platform by requiring all loans, except very short-term loans called "flash loans," to be overcollateralized and has a fail-safe liquidity pool known as the Safety Module.

• Its native AAVE token is used for governance and can be staked in the Safety Module for rewards.

About Aave: how does Aave work?

Aave, although originally built on Ethereum, is a multi-chain DeFi protocol, meaning it's supported by several blockchain networks, including Fantom and Avalanche. This is a particularly unique feature of Aave. It supports Ether and other ERC-20 tokens (tokens created using the Ethereum blockchain's ERC-20 standard) and operates in a peer-to-peer, decentralized manner as it's based on smart contracts.

So how does Aave work to maintain liquidity in its system? Well, it does that by requiring that all loans, except flash loans that typically last only a few seconds, be over-collateralized. It automatically liquidates the collateral of debtors who are unable to maintain their loan-to-value ratio (LTV) to repay a portion of their debt and restore liquidity. The LTV defines the maximum amount that can be borrowed with a specific amount of collateral. You might be wondering "what is Aave's LTV?" It's 75%.

When users deposit their assets into one of Aave's liquidity pools, an aToken (e.g., aETH) is minted and given to them. The aTokens serve as a claim to and have the same value as the deposited collateral. aTokens earn interest in real-time and can be redeemed for the underlying asset (collateral) at any time. They also entitle holders to a portion of the fees obtained from flash loans.

The interest earned by users fluctuates based on the lending supply and borrowing demand of the asset in question. Assets that offer higher interest rates often come with a higher risk of the user not being able to access sufficient liquidity, as they typically have utilization rates close to 100%.

Aave also has a designated liquidity pool, known as the Safety Module. What is Aave's Safety Module? Well, it acts as a fail-safe in case there's insufficient liquidity in the system. Users deposit their AAVE tokens in the Safety Module and earn more AAVE tokens as a reward. These tokens are sold off to restore liquidity whenever there's such a risk. The Aave protocol is governed in a decentralized fashion by the holders of the AAVE token.

Where is the AAVE token used?

AAVE is primarily used for governing the Aave protocol, as it grants the power to vote on matters concerning the protocol to its holders. With AAVE, you can vote on governance proposals and even create your own, enabling you to have a say in the future of the protocol. The more AAVE tokens you hold, the greater your voting power. AAVE's usefulness, however, isn’t limited to voting, as it can be used for several other tasks, including the following.

Trading

With the aid of a cryptocurrency exchange like OKX, you can speculate on the value of AAVE tokens in an attempt to make gains. It's worth noting that cryptocurrencies are highly volatile and shouldn't be traded by inexperienced individuals.

Earning interest

With a service like OKX Earn, you can earn interest on your AAVE tokens. OKX Earn, helps you to potentially make gains on your tokens over flexible and fixed terms while you maintain complete ownership of them.

Staking in the Safety Module

AAVE holders can "lock" their tokens in the Safety Module, which is the liquidity pool that acts as a safeguard against any liquidity issues that might occur. Users who deposit their tokens in this pool earn additional AAVE tokens as a reward.

The origins of Aave

Aave was founded in 2017 as ETHLend by Stani Kulechov while he was studying law at the University of Helsinki. At the time, Aave was one of the first DeFi protocols in existence.

Kulechov, who graduated with a Master's degree in law in 2020, now acts as CEO of Aave Companies (the organization that supports Aave) with a mission to create a more transparent, equitable, and inclusive financial ecosystem through the protocol, which is what brought about Aave in the first place.

Following its launch, Aave raised $17.8 million in an ICO with the goal of building a decentralized peer-to-peer lending platform, selling almost a billion units of LEND — its native token before rebranding to Aave. Upon switching to a liquidity pool model (from peer-to-peer lending) in 2018, the organization rebranded to Aave.

In 2020, Aave Companies launched the Aave protocol — the open-source, non-custodial protocol that it has since operated on. The launch of the Aave protocol attracted massive interest from users, with the "flash Loan" feature captivating cryptocurrency developers and enthusiasts from all over the world.

AAVE tokenomics

The AAVE token is the ERC-20-based native token of the Aave protocol. Its main use is for the governance of proposals about Aave, but it can also be traded freely on cryptocurrency exchanges and staked in the Safety Module for rewards.

AAVE, which started trading at around $50 in May 2020, has a total supply of 16 million. Before the "migration" from ETHLend to Aave, the token was called LEND. LEND tokens were later exchanged for AAVE after the migration at the rate of 100 LEND per AAVE, reducing the number of tokens held by users from 1.3 billion to 13 million. What is AAVE's circulating supply? At the time of writing, it stands at 14.9 million.

Three million AAVE tokens were also issued and allocated to the AAVE ecosystem reserve. This reserve is controlled by AAVE holders and the funds in it are intended to incentivize the development of the Aave protocol and ecosystem. AAVE's supply, like the protocol it spawned from, is highly decentralized, meaning no entity has a significantly large holding and thus an outsized controlling interest in the platform.

The revenue from fees charged to Aave's users is used to buy back and remove some of the tokens from circulation, a process common in DeFi known as "burning."

How is AAVE created?

You've probably wondered "what is AAVE's creation process?" Since it has no blockchain of its own and runs on multiple chains. AAVE is neither created by mining nor staking. So how does AAVE work? Well, it’s simply issued by the maintainers of the protocol according to previously laid out rules and systems.

The development team behind Aave would typically need the majority of Aave users to vote on a proposal to increase the supply before proceeding to do so. In the case of a "shortfall event", where a liquidity deficit has occurred or is likely to occur, AAVE tokens staked in the Safety Module are sold to cover the deficit. However, if this proves to be inadequate to restore liquidity, a proposal to issue more AAVE is then made to be voted on by the Aave community. If the community votes in favor of such, new AAVE tokens are issued and sold on the open market to cover the deficit.

AAVE's competitors and standing

Aave has a number of notable competitors, with the biggest ones, when ranked by TVL, being JustLend and Compound, according to DeFiLlama. JustLend, with a TVL of $3.24 billion at the time of writing, is the first and official lending platform of the TRON protocol and, just like Aave, allows users to borrow and deposit assets in pools in return for interest payments. Compound, which was once the largest by TVL but now has just $2.63 billion, is another decentralized Ethereum-based lending protocol that also provides liquidity pools to allow users to borrow and lend their assets for interest payments.

Aave is currently the largest and most popular borrowing and lending protocol on the Ethereum blockchain and in the world, boasting a TVL almost $2.4 billion greater than its nearest competitor, JustLend.

Aave's native AAVE token also leads its peers with a massive market cap of $1.4 billion, dwarfing Compound's COMP token at $562 million and JustLend's JST at $250 million.

Aave, unlike JustLend and Compound, is a multi-chain protocol, meaning it’s supported by more than one blockchain. Aave also has a higher LTV ratio than Compound, which means you can borrow more of an asset for a given amount of collateral on Aave than on Compound. And while they all offer reasonably similar annual percentage yields (APY), Aave is the only one that supports flash loans.

Aave's partnerships and investors

Aave is a highly composable DeFi protocol — it integrates with multiple other DeFi protocols to offer advanced features to its users and, as a result, has quite a number of partners. The project has partnered with other leading DeFi platforms like Balancer, Centrifuge, Uniswap, and MakerDAO, the largest DeFi protocol by TVL. It has also partnered with the popular and fast-growing Ethereum sidechain, Polygon.

Aave has raised a total of $49 million over 8 rounds of funding, including 4 ICOs, a seed round, and a venture round. The organization has raised this sum from a total of 16 investors, including some very high-profile names such as Alameda Research, Blockchain.com Ventures, Three Arrows Capital, and IBM.

Aave's SWOT analysis

Aave's strengths

Aave sets itself apart from the competition in many ways. One of its most distinguishing features is having multi-chain support, which allows it to support a wide range of cryptocurrency assets and cater to users beyond just one blockchain. Other notable strengths include its high level of composability, considerably higher LTV ratio than its competitors, support for flash loans, and the support of a for-profit organization, Aave Companies.

Aave's limitations

One Aave's main limitations is that it requires loans on its platform to be over-collateralized to minimize the risk of default. This could represent a significant barrier to adoption for many who’d prefer to make use of their assets rather than have them tied up as collateral. Aave also faces fairly stiff competition from new entrants and incumbents. Additionally, some fear that the protocol's cross-chain nature could make it more vulnerable to attacks.

Aave's opportunities

Aave allows users from anywhere in the world to access loans collateralized by easy-to-acquire digital assets without requiring them to have a credit rating or monthly income, as is typical with traditional lenders. This could prove very alluring to a lot of users underserved by the traditional financial industry. Additionally, its flash loans allow users to carry out trades and perform tasks unprecedented in the world of finance.

Aave is also taking steps to further scale its platform. Cross-chain governance, another rare feature of Aave, grants users the ability to send governance proposals across blockchains. Aave is now the first DeFi protocol to implement it, and it’s a feature that has the potential to further expand Aave's market. The Aave team has also announced the development of a mobile wallet and plans to expand to popular protocols Curve Finance and Sushiswap.

Aave's threats

Aave faces a lot of competition from established players as well as new upstarts, as competition in the DeFi lending space continues to heat up. New competitors are constantly entering the lending market in a bid for their own share of it. Aave, like its peers, also faces the risk of unfavorable regulatory policies and the theft of their community's funds.

Aave 2030 roadmap

Aave Labs has proposed a 'temp check' roadmap, "Aave 2030," to keep the Aave Protocol at the forefront of decentralized finance (DeFi) by innovating and scaling to reach the next billion users. The project has put forward a proposal to launch Aave Protocol V4, which will improve liquidity across the network, add real-world assets (RWAs), and create a new look for the protocol.

Key components of the proposal

• Aave V4: The next version of the protocol promises major technological progress.

• Cross-chain liquidity layer (CCLL): Enhances Aave's ability to give liquidity across multiple blockchain networks by using new tech to make instant liquidity access possible.

• Real-world assets (RWAs): V4 aims to incorporate RWAs into Aave's ecosystem through its stablecoin, GHO, to increase its functionality.

• Aave network: A network that would be the main hub for Aave and GHO is also planned. The network would be multichain and network-agnostic, improving governance, and theoretically making transactions cheaper.

Goals and timeline

• First year: Launch a new visual identity, develop an Aave V4 prototype, integrate GHO with RWAs, and support one non-EVM chain.

• Second and third year: Establish the Aave Network, implement CCLL, further RWA integration, and develop additional Aave Labs products.

Community involvement

Aave Labs emphasizes community participation by proposing annual reviews to ensure alignment with the goals of the Aave DAO. The organization plans to progressively reduce its technical contributions, empowering the community to take the lead.

Funding

Aave Labs is requesting a three-year grant. The initial funding request is $3 million GHO upfront, followed by $12 million GHO and 25,000 stkAAVE streams over the first year. This approach aims to ensure proactive engagement and a mutual understanding of the objectives and timeline.

Aave news, updates, and highlights

AAVEconomics update proposal

A July 2024 proposal aimed to solve secondary liquidity inefficiencies. The new 'Umbrella' proposal effectively manages and clears excess debt without affecting token value or stability. Initially, protections for GHO (stablecoin) and AAVE tokens will be separate, increasing GHO protection.

Meanwhile, a new staking and reward system upgrades the StkGHO Safety Module for dual rewards. Here, an efficient debt clearance approach replaces the “seize and sell” method. And, a new Anti-GHO token mechanism helps GHO borrowers reduce debt, aligning stakers and borrowers. The plan aims to conclude the previous LEND token migration and transfer any remaining balances to the ecosystem reserve. New Safety Modules for aTokens (for example, awETH, aUSDC) will be added to cover most of the protocol’s debt, providing better protection at lower costs.

Additionally, a “Buy & Distribute” program will use protocol revenue to purchase AAVE tokens from secondary markets and distribute them to stakers, guaranteeing sustainable rewards. The community’s feedback will be collected, and if a consensus is reached, the proposal will proceed to a formal vote.

GHO stablecoin

In July 2022, the company supporting the Aave protocol announced that it is going to be launching a stablecoin called GHO. Users must provide collateral to mint GHO, and like loans on Aave, GHO must be overcollateralized. The stablecoin, which in many ways is similar to MakerDAO's DAI, will have its value pegged to the US dollar and be backed by a basket of crypto assets chosen by users. Users also earn interest on their deposited collateral.

In July 2024, Aave DAO officially launched its stablecoin, GHO, on the Arbitrum network. The launch is part of its plan to expand across different chains in phases.

The move marks the first time GHO has become available on a network other than Ethereum. Using Chainlink’s Cross-Chain Interoperability Protocol (CCIP), GHO is designed to increase accessibility, reduce transaction costs, improve liquidity, and foster broader adoption by expanding to other networks over time.

Arbitrum, the Layer-2 network with $19 billion in total value locked (TVL), was selected as the first platform due to its strong user base and lower fees. GHO can be borrowed in Aave’s Arbitrum pool, improving its functionality in DeFi. The cross-chain rollout is designed to be safe and efficient. It uses CCIP’s advanced features like rate limits, programmable token transfers, and a well-tested codebase to make sure transfers are safe across the chain.

GHO’s architecture allows each chain to have its own version of the stablecoin, backed by Ethereum reserves. On Arbitrum, the stablecoin uses a lock-and-mint model to ensure collateralization during transfers, while future non-Ethereum chains will use a burn-and-mint model to optimize capital capability.

Expansion to Curve and Sushiswap

In an attempt to scale its markets, Aave has announced an expansion to DeFi protocols Curve Finance and Sushiswap, two of the largest decentralized exchange (DEX) protocols on Ethereum.

Mobile wallet

On January 1, 2022, Aave CEO Stani Kulechov announced that the team was building a mobile wallet. The price of AAVE reacted positively to the news.

Gasless voting

Several holders of the AAVE token, especially those with small holdings, don't participate in voting on Aave's governance proposals due to the high gas fees involved in doing so. To solve this and improve inclusivity, the Aave team is trying to implement a feature that’ll allow users to vote on proposals for free.

Aave and Flash Loans

Flash loans, invented by the Aave development team, are a new financial tool. Flash loans are instant, uncollateralized loans that must be repaid in a single transaction. They take advantage of a blockchain's ability to revert transactions if certain conditions aren’t met. The condition, in this case, is that the borrowed funds must be returned to the lender before the transaction is completed. Lenders are paid a fee as an incentive, which makes flash loans particularly alluring to them since they are technically risk-free.

A flash loan allows a user to swap debt and collateral in a collateralized loan on Aave, so that they might, for example, swap volatile collateral for a stable one and avoid the risk of being liquidated. So, for example, if a user borrowed USDT while using ETH as collateral on Aave and the price of ETH was crashing, the user could take out a Flash loan right on Aave to swap their volatile ETH collateral for less volatile crypto or stablecoin.

Aave 3 launched on the Era Mainnet

In August 2024, Aave V3 launched on the Era Mainnet, which is powered by ZKsync technology. The development brings many benefits to the Aave community such as low-cost, secure transactions through advanced zero-knowledge (ZK) technology.

ZKsync also allows for fast and efficient transactions while maintaining Ethereum-level security through cryptographic proofs. Chainlink will provide reliable and secure price feeds for the protocol as part of the integration.

This deployment aims to improve the user experience and expand Aave's role in the growing Elastic Chain ecosystem. It's also designed to bolster DeFi applications that focus on privacy. These applications will be better equipped to meet the growing need for privacy, while opening up new ways for institutions to adopt them. For example, creating networks that are tailored to specific asset classes and risk profiles.

Aave’s overcollateralized stablecoin, GHO, and other future products will also benefit from this integration, enabling faster and cheaper payments. After positive technical and risk evaluations, the Aave DAO has approved key assets like USDC, USDT, WETH, and wstETH for use on the Era mainnet.

Any airdrops from the ZKsync ecosystem will be distributed to Aave users through liquidity mining campaigns and other rewards. This will be done by the Aave Chan Initiative (ACI).

Where to buy AAVE

One of the easiest ways to buy AAVE is via a centralized cryptocurrency exchange like OKX. OKX lets you purchase AAVE using your credit or debit card or bank transfer, among a range of other payment options. OKX supports over 92 local currencies and even lets you buy AAVE with other cryptocurrencies.

How to store AAVE

On an exchange such as OKX

Centralized exchanges like OKX provide you with crypto wallets where you can store your assets and abstract away all the complexities of securing and using them. OKX's wallets, for example, can hold multiple different assets, saving users the hassle of having to maintain multiple different wallets and private keys. Though storing your assets on centralized exchanges comes with many benefits, it’s generally not advised for users who want to store assets for extremely long periods.

In an ERC-20 wallet

Aave is an ERC-20 token, and so it can be stored in any ERC-20-compatible digital wallet like Metamask or MyEtherwallet. It’s worth noting that the burden of storing and securing your private keys will be entirely on you if you store your tokens this way.

In a hardware wallet

Hardware wallets like the Ledger Nano S or Ledger Nano X are reputed to provide the best security for your assets. However, they may be too expensive or technical to use for some and will require you to secure them by yourself.

How to stake AAVE

You can stake your AAVE tokens via OKX Earn. OKX Earn lets you stake AAVE over variable and fixed periods and earn passive gains in return. You retain complete ownership of your AAVE and can withdraw them at any time.

Aave tokens can also be staked in their native decentralized app (DApp). These are typically done in the Safety Module, where they earn a portion of Aave's transaction fees for their owners.

The final word

Aave's decentralized non-custodial borrowing and lending protocol provides an opportunity for users to grow their assets by depositing them into liquidity pools. And at the same time, users can access uncollateralized, ultra-short duration loans, allowing them to capitalize on arbitrage opportunities.

Through its services, Aave set out to disrupt the financial ecosystem with a solution that's more transparent, equitable, and inclusive.

Interested in learning more about the opportunities presented by Aave? If so, read up on our guide to lending and borrowing cryptocurrencies through the platform.