Aave Crypto Protocol 101
Aave is a protocol for decentralised finance (DeFi) that lets people lend and borrow cryptocurrencies and real-world assets (RWAs) without going through a central intermediary. When they lend, they get interest; when they borrow, they pay interest.
Aave was originally built on top of the Ethereum network. All of the tokens on the network, which are called ERC20 tokens, also use the Ethereum blockchain to process transactions. Since then, Aave has grown to include other chains like Avalanche, Fantom, and Harmony.
A decentralised autonomous organisation, or DAO, is used by the protocol itself. That means it is run and ruled by the people who own AAVE tokens and use them to vote.
How lending works on Aave
In the past, if you wanted a loan, you had to go to a bank or other place with a lot of cash on hand. In exchange for the loan, the bank will ask for collateral. For a car loan, this would be the title to the car. Then, every month, you pay the bank the principal plus interest.
DeFi is different. No bank is there. Instead, the heavy lifting is done by “smart contracts,” which are computer codes that automate transactions, like selling if the price of a token reaches a certain threshold. DeFi gets rid of the middlemen in trading assets, futures contracts, and savings accounts.
In practise, this means that people, not banks, can lend you money in the form of cryptocurrency. But you still have to put up something as security. In a DeFi system that tries to be fiat-free, this means other cryptocurrency tokens.
And because cryptocurrency is so unstable, a lot of DeFi platforms ask for extra collateral. So, if you wanted to borrow $500 in cryptocurrency from Aave, you’d have to put up more than $500 in another cryptocurrency.
If the price drops and the amount you put up as collateral is no longer enough to cover the amount you’ve borrowed, your collateral can be “liquidated,” which means the protocol takes it to pay for the loan.
Aave has pools for 30 Ethereum-based assets right now, including the stablecoins Tether, DAI, USD Coin, and Gemini dollar. Avalanche, Fantom, Harmony, and Polygon are some of the other markets.
Aave also has pools for real-world assets like real estate, cargo and freight invoices, and payment advances.
partner company called Centrifuge helps brick-and-mortar businesses tokenize parts of their operations so they can take part in these pools.
Once tokenized, investors can buy (or use as collateral) these tokens, which act like bonds and give investors a return on what they hold. So, businesses in the real world can use these assets as collateral to borrow money.
Why would you want to get money in crypto?
Even though it usually makes more sense to buy or sell cryptocurrency, there are times when it makes sense to borrow it. Arbitrage is one of the most obvious.
If different exchanges have different prices for the same token, you can make money by buying it at one place and selling it at another.
But when you take into account transaction fees and spreads, the differences are usually small, so you’d need a lot of the cryptocurrency to make a good profit.
This is why Aave has flash loans. Aave was the first company to use “flash loans,” in which people borrow cryptocurrency without putting anything up as collateral, use it to buy an asset, sell that asset, and then return the original amount while keeping their profit in the same transaction.
How money pools work?
Let’s go to DeFi again. In the early days of decentralised finance, if you wanted to borrow an asset, you had to find someone on the platform who would lend it to you at a price and on terms that you both agreed to.
Since then, things have changed.
Aave skips the whole peer-to-peer lending process and goes straight to what is basically pool-to-peer lending.
How does that work? Users deposit digital assets into “liquidity pools.” This gives the protocol money that it can then lend out.
Whoever puts their tokens into a pool and “provides liquidity” by doing so gets new aTokens. (The “a” stands for “Aave.”) So, if you put DAI into the liquidity pool, you will get back aDAI.
As an owner of aTokens, you’ll get a share of the platform’s flash loans and interest on your aTokens.
If you put tokens into a pool that already has a lot of extra cash, you won’t make much money. But if you put in tokens that the protocol really needs, you will make more.
The same is true for people who want to borrow money: interest rates change depending on what you want to borrow.
In March 2022, Aave released protocol version 3, which has a feature called Portal. Portal makes it possible for Aave to work smoothly on all blockchains.
This means that you can now use Aave to take part in protocols for lending or borrowing on chains like Solana or Avalanche.
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