Introduction

The advent of decentralized finance (DeFi) brought a new dimension to the crypto space. It opened up different opportunities individuals can tap into to make more money. The major attraction is how it challenges the traditional financial systems of lending, borrowing, and trading. Thus, individuals are asking how they can maximize DeFi’s benefits.

Aave, a DeFi money market protocol, is a pioneering platform that ushered in the era of new profit opportunities. Due to its revolutionary features and history in the DeFi and crypto ecosystem, it has gained widespread popularity pushing up interest in the Aave protocol and its token (AAVE). 

Today, we look through everything you need to know about Aave protocol before investing in AAVE.

What is AAVE? | Definition of AAVE

The first that comes to mind when you think of learning about Aave (AAVE) is “What is AAVE?” This question is fundamental to gaining more insights into how Aave protocol works before investing in AAVE. Let’s get into the definition of AAVE.

Aave is a decentralized finance (DeFi) protocol that allows individuals to borrow and lend cryptocurrencies and real-world assets (RWAs) directly without needing a centralized intermediary. This means lenders will earn interest and other incentives on their loans, and borrowers will pay interest on loans obtained through the platform.

Aave enables an anonymous transaction mode regarded as peer-to-peer interaction. Individuals don’t know who they transact with, but these lending and borrowing activities occur through pools. Lenders send their tokens into the pools where borrowers lend from.

Aave is an open-source protocol originally built on the Ethereum network. As a result, the Ethereum blockchain is used to process transactions that involve ERC20 tokens. The protocol expanded to other chains such as Avalanche, Fantom, and Harmony to enable more seamless and cheaper alternatives.

History of AAVE | ETHLend Before Aave

As a DeFi lending platform, Aave was first introduced into the crypto ecosystem as ETHLend in 2017, where it raised $16.2 million in funding. Its sole purpose was to make crypto borrowing and lending a peer-to-peer (P2P) activity that eliminates intermediaries. This makes it more efficient than using the traditional approach to disbursing loans to borrowers.

Initially, the platform allowed users to borrow and lend loans using Ethereum (ETH) as collateral in a secure P2P network. Later on, the platform introduced its ERC20 token, LEND, to process transactions or grant borrowers and lenders incentives.

With continuous improvement despite the challenges DeFi faced as an innovative entity, the team kept improving the platform. As a result, ETHLend went through a significant rebranding and became Aave. This rebrand ushered in new features that made the platform more robust and user-friendly.

Part of the new development was the introduction of the Aave Protocol, which allows users to move their assets across different DeFi protocols without hassles while using its smart contracts. Likewise, stablecoins such as USDC, DAI, and GHO were integrated into the platform.

How Does Aave Work?

Aave is an algorithmic lending platform where lenders and borrowers are automatically matched through smart contracts. Lenders put their crypto tokens in the liquidity pools and earn interest based on how much they deposit and lend, a concept known as utilization rate. The algorithm allows borrowers to obtain crypto loans from the liquidity pools without an intermediary.

The interest borrowers pay depends on how many assets lenders put in the pools. When all of your assets as a lender are used, you receive higher interest rates and more incentives as you deposit more assets for lending. Otherwise, the interest rates are reduced when all assets are not used from the pools. This attracts more borrowers to join the platform.

Thus, lenders depend on borrowers as much as borrowers depend on lenders for crypto loans. However, Aave loans require high collateral before you can borrow. The collateral you deposit as a borrower has a higher value than the crypto loan you want to obtain. Thus, you lose your collateral when you refuse to repay the loan at a stipulated time.

Now, let’s examine different lending and borrowing features on Aave.

AAVE’s other Lending and Borrowing Features

Aside from Aave's primary lending and borrowing features, other lending features exist on the platform. This gives users more flexibility to harness the financial opportunities that exist on the platform.

Flash Loans

One of Aave’s innovative features is the flash loan. This is a kind of loan that you obtain and repay within the same block without the required collateral for a regular loan. This loan taps into the arbitrage advantages that exist in the crypto market. This can be the price difference between cryptocurrencies on various cryptocurrency exchanges.

Aave’s flash loans are executed within minutes or seconds. They are conducted within the timeframe required to add a new block on a blockchain. When you request a loan, the repayment requires that you pay back a 0.09% fee in the same block. The transaction will fail, and you won’t be able to obtain or borrow any funds if you cannot meet these conditions.

Liquidation

Liquidation is a feature that allows users to pay back part of their loans when the price of AAVE drops below a particular loan-to-value (LTV). This process involves selling about 50% of the collateral submitted to repay the loan. This will bring back the LTV to the limits within the loan agreements.

On the platform, liquidators are users that execute liquidation. They repay the loan through liquidation and claim the collateral with an additional 5% bonus.

Pros and Cons of AAVE

Where to Buy AAVE

Now that you are interested in crypto lending and borrowing, the next question is where to buy and start using AAVE. You can buy AAVE directly from Aave or other exchanges that list it. 

You can buy AAVE from popular exchanges such as Binance, Coinbase, Kraken, CEX.io., etc.

Should You Invest in AAVE? | Conclusion

Investing in AAVE might be the next best shot you will be taking in the crypto industry. This is because DeFi is revolutionizing loan uptake of the traditional financial system through its decentralized automated crypto borrowing and lending while also serving as a financial tool. And the growing adoption of DeFi is a solid reason to invest in AAVE.

However, before you buy or invest in AAVE, you should do your own research. Do well to manage your risks, and if you're new to the system, it's best to seek professional financial advice. This article is for educational purposes and is not financial advice.

Click here to see our top 10 cryptocurrencies to invest in this year.