Aave Review

What is AAVE?

Aave is a multichain lending and borrowing platform. The project is non-custodial, which means it doesn’t directly hold its users’ funds, instead, Aave keeps crypto locked in its smart contracts. 

DeFi Teller has also prepared a video review of Aave, check it out bellow!

Since its 2020 launch on Ethereum, Aave has released v2 and v3 of its protocol. Nevertheless, one feature innovated by Aave and available to its users since Aave v1 remains considered a cornerstone in the development of the whole DeFi sector – Flash Loans. More than that, Aave v1 also introduced users to aTokens – interest-bearing derivative tokens that are pegged to the value of deposited assets and can be transferred on the blockchain, while bringing holders’ interest continuously.

When Aave v2 was launched in December 2020, the project had long ago passed $1 billion in market size. Although the developers’ team released numerous new features and updates, such as Batch Flash Loans; Stable and Variable Borrowing Rates optimizations, and many others, Aave v1 remains operational in parallel to Aave v2 and Aave v3 to this day. Aave v2 was also the project’s first look into its multichain future. The dApp was released on Polygon and Avalanche besides the Ethereum mainnet.

More than a year after the success of Aave v2, in March 2022, Aave released its latest iteration – the v3 of the protocol. Besides being deployed on Ethereum, Polygon, and Avalanche similarly to v2, Aave v3 is also live on Optimism, Arbitrum, Harmony, and Fantom. This version of Aave brought a new set of innovations and optimizations to the protocol, such as Portal - a feature allowing users to transfer their supplied liquidity from one network to another; High efficiency and Isolation modes - providing borrowers with higher borrowing power and limiting exposure from newly listed assets, respectively; and various risk management improvements, among others.

Here is a table visualizing the different blockchains supported by Aave:

dApp Version	Ethereum	Polygon	Avalanche	Optimism	Arbitrum	Harmony	Fantom
Aave v1	yes	no	no	no	no	no	no
Aave v2	yes	yes	yes	no	no	no	no
Aave v3	yes	yes	yes	yes	yes	yes	yes

 

How does AAVE work?

To provide its users with the ability to lend and borrow crypto without an intermediary, Aave utilizes smart contracts. These smart contracts are meant to act as liquidity pools, storing deposited assets that borrowers can utilize in exchange for a fee, which is distributed to lenders depending on their share of the pool’s balance. This is made possible thanks to Aave’s aTokens, designed to generate interest among other benefits.

What are aTokens

aTokens are based on the ERC20 standard (updated to also implement EIP-2612, with Aave v2) and designed to be minted when users deposit funds into the protocol and burned when funds are redeemed. The value of aTokens is pegged to the value of their corresponding deposited assets at a 1:1 ratio. Although the interest generated by aTokens is distributed to their holders directly, they can also choose to redirect these payments to any other supported wallet address. Furthermore, aTokens can be traded, transferred, or used in other DeFi protocols. 

Essentially, aTokens are meant to represent deposited assets into the protocol and used to generate and redeem profit, while providing holders with more flexibility as they can also be traded or used to generate additional interest through third-party blockchain protocols. 

Aave interest rates

After funds are deposited into the protocol, Aave depositors’ benefits depend on the interest rate set in the liquidity pool where their assets have been deposited and their share in it. 

In Aave v1, the interest rate is calculated and set automatically through a smart contract called InterestRateStrategy, deployed on the Ethereum mainnet. Each liquidity pool on the platform has its own, specific InterestRateStrategy contract, providing both for a variable borrow rate and a stable borrow rate. These smart contracts are tasked with constantly updating interest rates while taking into account the optimal interest rate utilization parameters set with the creation of the pool, and the dynamic costs of the assets in the liquidity pool. 

With the later releases of the protocol, the strategy model has been further improved by the addition of a new parameter – Optimal Stable/Total Debt Ratio, which manages the stable rate algorithmically.  Further details are available both in the Aave whitepaper and the project’s documentation portal.

Simply put, Aave’s interest rate strategy is dynamic as it is meant to manage liquidity risks while also optimizing capital utilization. The smart contract lowers interest rates when there are a lot of assets available in order to encourage loans, and raises the rates when capital is scarce to encourage repayments of loans and additional deposits.

Collateral on Aave

When using the platform to borrow assets, users are requested to deposit collateral in the form of another crypto asset, supported by Aave. This is done to ensure lenders’ protection in the event of a default. Every asset on the platform has its own collateral ratio depending on the volatility and other risks specifically associated with the asset. 

With Aave v2 the risk parameters were updated to be “more aggressive”, as described in the Aave docs since the project and its ecosystem had become “more mature”. Moreover, Gauntlet was chosen following a governance proposal to manage and optimize the collateral parameters for all assets supported by the platform weekly.

When Aave v3 got released, the project’s risk mitigation tools got much better as entirely new features were added. Such are Aave Supply Caps which define the maximum amount of an asset that can be supplied to the protocol and Aave Borrow Caps – setting the maximum amount of an asset that can be borrowed. There is also an Isolation Mode limiting an asset to only borrow isolated stablecoins while using a single isolated asset as collateral. Aave v3’s Siloed Mode is meant for assets with “potentially manipulatable oracles” (as described by the documentation of the feature). An asset put into Siloed Mode restricts its borrowers from borrowing any other asset. There is also Efficiency Mode, or eMode, including assets correlated in price providing users with better capital efficiency. Currently, the only eMode category on Aave is Stablecoins. 

Deposits used as collateral on Aave go into liquidity pools and can only be withdrawn once they are no longer used as collateral. To define how much assets can be borrowed against a user’s deposited collateral, Aave uses a dynamic Loan to Value (LTV) ratio depending on market conditions expressed in percentages.

Aave liquidation and liquidators 

Liquidation on Aave v1 can occur once the LTV of a borrower’s position reaches the liquidation threshold set through the platform’s governance system. This can happen due to various reasons such as the collateral’s decrease in value or the borrowed debt’s increase in value against the deposited collateral. 

In Aave v2, the project introduced a Reserve factor allocating a share of the protocol’s interests to a smart contract meant to act as a Reserve fund for the platform. This fund is also used to pay for contributions to the protocol and sustain the DAO. The Aave Reserve Factor is a fee calculated based on the risk accrued by trades with more volatile assets.

Aave v3 has a Liquidation Penalty fee set on the value of the assets allocated to a position that has passed the liquidation threshold. This fee is taken from the available collateral.

The collateral versus LTV ratio on Aave is represented through a so-called Health Factor, calculated by taking into account the collateral’s Ethereum value, the liquidation threshold, and the total Ethereum value of the specific users’ borrows. If the Health Factor reaches a value lower than 1, its correlated position may be liquidated.  

What are Flash Loans?

Aave pioneered a financial product called flash loans that enable short-term borrowing without the use of collateral. These loans are meant to be repaid in a single Ethereum transaction and are available to anyone. The most common use cases for flash loans include arbitrage opportunities, liquidations, and liquidity provision, however, flash loans have become notorious for their use case in hacks and exploits on other DeFi protocols, with some sources reporting over $207.5 million worth of crypto stolen by Flash Loan attacks in the first two and a half months of 2023. 

Interacting with Flash Loans is only possible by developing a smart contract consisting of three parts. The first part is responsible for borrowing assets, while the second is meant to interact with a smart contract (for example liquidate an undercollateralized position on Aave or a different lending market), and lastly, the final part of the contract returns the funds borrowed. 

How to use AAVE?

When using the Aave app, users need to choose the version of the protocol they wish to interact with. After that, they need to connect a wallet and switch to a blockchain network supported by the Aave version they are using. Besides physical and browser wallets, Aave can be used with any wallet supporting the Wallet Connect protocol. 

Once a wallet has been connected to the Aave v1 dApp, users can navigate in it through a menu on the left side of the screen. The main functions – Dashboard, Deposit, and Borrow are listed on top of the menu. 

In v2 and v3, the user menu is moved to the upper part of the screen and in order to deposit users first need to pick a Market. 

Lending on Aave

When depositing assets to the platform users can choose to not use them as collateral. There is no minimum or maximum limit to the amount of funds that can be deposited to Aave liquidity pools and users can withdraw their funds at any time, as long as they are not being used to collateralize a loan. However, in case a pool doesn’t have enough liquidity to facilitate the withdrawal, users may need to wait for it to add up.

Withdrawal can be done by navigating to the dashboard section and clicking on the “withdrawal” button, then choosing the amount of funds to be withdrawn. For those who wish to, aTokens can be freely used in the form of liquidity and even traded with other crypto holders, thus keeping the liquidity in the pool. 

Borrowing on Aave

When borrowing on Aave users need to first deposit collateral in the protocol through the Deposit section for Aave v1, and the supply function on the dashboard in Aave v2, and Aave v3. 

After that, they simply need to head to the Borrow section and click on the “Borrow” button next to the asset they wish to borrow. Once the amount has been set and the stable or variable rate has been chosen, the transaction needs to be confirmed through the user’s wallet. 

When repaying loans users can do that in the same asset they borrowed, including the accrued interest. Following the release of Aave v2 it is also possible to use the provided collateral in the repayment of debts.

Aave Variable and Stable Interest rates

The Aave stable interest rate is meant to provide for predictability, however, this comes at a cost as it is usually higher than the Aave variable interest rate. The stable rate is fixed until the utilization rate goes over 95% and the overall borrow rate or the weighted average of all the borrow rates goes under 25%.

The stable interest rate includes is calculated based on the optimal utilization rate, the base variable borrow rate, the stable to total debt ratio, and two vectors named Variable Rate Slope 1, and Variable Rate Slope 2, respectively. 

The Variable Interest Rate is calculated based on the optimal utilization rate, the base variable borrow rate, and the Variable Rate Slope 1 and Variable Rate Slope 2 vectors. The variable rate is dynamic and gets updated constantly. 

Stable and variable interest rates can be changed at any time from the Aave app’s dashboard in v2 and v3, by clicking on the APR Type button and choosing the preferred option.

Becoming a Liquidator on Aave

Becoming a Liquidator is open to anyone, however, it requires a certain level of technical knowledge as liquidators normally develop their own solutions to try and be the first ones to get the chance to liquidate an undercollateralized position on the platform. Additional details and tutorials can be found on the Aave documentation hub’s webpage. 

The AAVE token

The native asset of the Aave ecosystem, used in its governance and as a form to safeguard the protocol from bad actors is the AAVE ERC-20 token. However, in the early days of the project, its native asset was called LEND. The project’s founder held a successful ICO in 2017 and managed to raise $16.2 million at a price of $0.016 per token. 

LEND migrated to AAVE in 2020 and massively decreased the total supply of the asset – from 1.3 billion LEND to just 13 million AAVE tokens. Token holders were able to swap at a rate of 100 LEND for 1 AAVE. 

With the release of the AAVE token, came the project’s decentralized governance system which allowed community members to propose AAVE Improvement Proposals (AIPs).

The initial distribution of the AAVE token was the following:

• 30% for the core development team
• 20% for user experience development 
• 20% for management and legal fees
• 20% for promotions and marketing
• 10% for miscellaneous costs

Staking Aave

Staking is the second biggest use case of the AAVE token. It is provided for by a so-called Safety Module integrated into the Aave protocol’s smart contracts. It allows users to deposit AAVE tokens in it that may be used in the event of a shortfall by being auctioned on the market to mitigate the deficit. In exchange for participating in the program, staked AAVE holders are rewarded with more AAVE tokens. 

To participate in the AAVE staking program, users need to head to the Aave app’s staking section, click on the “Stake” button and input their desired amount. After that, they need to send an approval transaction, followed by another transaction that performs the actual staking.

To stop staking, or unstake their AAVE tokens, users first need to activate the cooldown period by sending a transaction through the app’s “Unstake” button located in the staking section of the Aave dApp. Once the cooldown period finishes funds can be withdrawn with another transaction.

Is Aave safe?

Aave has undergone numerous audits. The v1 protocol has been audited by Gauntlet, Open Zeppelin, and Trail of Bits, the v2 was checked by Gauntlet, Consensys Diligence, Sigma Prime, PeckShield, and Mixbytes, while the v3 was audited by Sigma Prime, PeckShield, Certora, Open Zeppelin, Trail of Bits and ABDK. All major issues found have been fixed by the Aave team.

Furthermore, the AAVE token has gone through three audits – from Consensys Diligence, CertiK, and Certora. The project’s Safety Module has also been audited independently by Gauntlet, Consensys Diligence, and CertiK. Besides that, the Aave governance module has been audited by Consensys Diligence. All major issues found have been resolved.

Aave runs a bug bounty program with rewards of up to $250,000. The program was launched in March 2022 with the release of the Aave v3 protocol. Additional details are available on Aave’s GitHub webpage.

The Aave team

Aave was founded by Stani Kulechov and currently has over 115 employees spread around the world. The company is headquartered in London, UK, while also maintaining an office in Chiasso, Switzerland. The Aave management team also includes CFO Peter Kerr, Director of Strategy Nicolo Stewen, and many others. 

Partners and collaborations

According to public information available online, Aave has had 9 funding rounds so far and has managed to raise over $49 million. The biggest raise following the Seed Round in 2017 which managed to bring Aave $16.5 million, was a Venture Funding Round that took place in October 2020 and was led by Blockchain Capital, with participation from Blockchain.com Ventures, and Standard Crypto. The event raised $25 million for the development of the project.

Among the many successful partnerships, Aave also has numerous forks whose TVL is estimated to be in the hundreds of millions of US dollars. 

There are dozens of projects in the Aave ecosystem. The Chainlink oracle has been integrated to ensure that users have the latest market info. A partnership with the Synthetix protocol allows trading derivatives on Aave. 

Decentralized exchange aggregators 1inch, Paraswap, and JellySwap as well as interest swaps market OpiumNetwork all collaborate with Aave. The ecosystem also includes portfolio trackers Unspent and DeFi Snap, automated yield rebalancers Idle Finance, Totle, and Stake Capital.

Aave also stands behind Aavegotchi, a crypto RPG game developed by Pixelcraft Studios featuring staked NFTs with interest-generating aTokens, launched on Polygon. 

Another interesting venture led by Aave CEO Stani Kulechov is Lens-Protocol – a permissionless, decentralized social media-like app, utilizing NFTs to facilitate and incentivize user activity.  

What's next?

One of the most promising upcoming innovations by Aave is the launch of its own stablecoin – GHO. The token is meant to be a decentralized, multi-collateral, stablecoin. Although pegged to the value of the US dollar at all times, GHO will be operating under a multi-currency, over-collateralized minting model. The stablecoin will be launched on the Ethereum mainnet. All interest collected through the minting of the asset will go to the Aave DAO treasury.

Other upcoming innovations from Aave can be found by browsing the project’s governance forum, where all proposals are extensively discussed and an active community is available to provide information at nearly all times.

Links

https://docs.aave.com/hub/

https://governance.aave.com/ 

https://github.com/aave/aave-v3-core/blob/master/techpaper/Aave_V3_Technical_Paper.pdf