Résumé
The AAVE token is the native token of the protocol. AAVE holders can discuss and vote on proposals that directly affect the platform.
The Aave protocol is one of the most important in the DeFi ecosystem. The AAVE token is among the top most valued DeFi cryptocurrencies. Thanks to Aave, Ethereum investors can easily borrow and lend their cryptocurrencies in a decentralized manner.
Introduction
In all modern financial ecosystems, individuals can borrow or lend their assets. Borrowing allows you to leverage your capital to obtain a better return. Lending, on the other hand, allows you to obtain a regular and secure return.
Crypto ecosystem developers, realizing this need, have launched what we call money markets. In these markets, Aave is in many ways one of the leaders.
What is Aave?
Aave is an Ethereum-based money market where users can lend and borrow both stablecoins and altcoins. The Aave protocol is governed by the holders of the AAVE token.
It would be difficult to understand the role of the AAVE token in this protocol without understanding it.
ETHLend
Let's go back to the origins of the project, in 2017. In November 2017, Stani Kulechov and a team of developers launched ETHLend via an Initial Coin Offering (ICO). The idea was to allow users to borrow and lend cryptocurrencies via a system of loan requests and proposals.
Although ETHLend is an innovative idea, the platform and its token, LEND, fell victim to the 2018 bear market. The platform also suffered from two major problems: lack of liquidity and difficulty in matching loan requests with offers.
From 2018 to 2019, the ETHLend team took advantage of the bear market to improve its product and released Aave in 2020.
In a podcast, Kulechov will explain that ironically, the bear market was the best thing that happened to ETHLend. Why? Simply because this downtime allowed them to develop the concept of decentralized cryptocurrency lending, which would give birth to the protocol we know today.
How does Aave work?
The improved version of Aave remains similar to the concept of ETHLend. Ethereum users can borrow cryptocurrencies or lend them in exchange for a financial reward. There are, however, some differences.
Aave is an algorithmic money market, meaning that loans come from pools, not from user-initiated offers.
The interest rate charged depends on the "utilization rate" of the pool's assets. If almost all of the pool's assets are used, the interest rate increases to encourage individuals to provide more capital. Conversely, if the pool's assets are hardly used, the rate charged is low, thus encouraging borrowing.
Aave also allows users to take out loans in cryptocurrencies other than the ones they deposited. For example, a user can deposit Ethereum (ETH) to borrow stablecoins and use them on Yearn.finance (YFI) to earn a steady yield.
Like ETHLend, all loans are overcollateralized. This means that if you want to borrow $100 worth of cryptocurrency on Aave, you need to deposit much more than that amount.
Due to market volatility, Aave includes a liquidation process. If your collateral falls below the protocol’s collateralization ratio, liquidation occurs. Note that additional fees will be charged in the event of liquidation. Make sure you understand the risks of depositing funds into Aave before borrowing or lending cryptocurrencies.
Other important features
Aave isn’t stopping at money markets. The platform has gained popularity in the DeFi space by offering its users the chance to take out quick loans.
This success allows the Aave protocol to have more liquidity in its pools than money required by its borrowers. This excess liquidity can therefore be used for quick loans. These are uncollateralized loans that only exist for the duration of a block of the Ethereum blockchain.
To put it simply, a quick loan allows the user to borrow a large amount of cryptocurrency without depositing collateral. The loan is then repaid in the same transaction that made it possible to take it out. It is therefore a loan that lasts a few seconds.
Fast loans allow those without a lot of capital to arbitrage or take advantage of a good opportunity, all in a single transaction on the blockchain. For example, if you see that Ethereum is trading around 500 USDC on Uniswap and 505 USDC on another decentralized exchange, you can arbitrage and borrow a large amount of USDC to sell it at the best price.
In addition to borrowing, lending, and quick loans, Aave is also working on Aavegotchi, a non-fungible token (NFT) game.
AAVE enters the track
While ETHLend was rebranded to Aave, its native token LEND remained the same. This was problematic, as LEND did not have the proper code to meet the expectations of the Aave team. Indeed, LEND holders could not participate in the governance of the Aave protocol.
As the protocol gained popularity, the Aave team wanted its community to decide the future of the platform. It was therefore decided that the LEND token would be exchanged for a new token, the AAVE, at a 100:1 ratio (100 LEND = 1 AAVE).
Aave is an ERC-20 token based on the Ethereum blockchain. It has several use cases.
First, Aave holders act as the backing of the protocol. AAVE introduces the concept of a “Safety Module,” which protects the system against a capital shortage. Thus, if there is not enough capital in the protocol to cover the lenders’ funds, the AAVE staked in the Safety Module is sold for the assets needed to cover the deficit.
Of course, only AAVE deposited in this module are liquidated. Users depositing AAVE in the module receive a regular yield paid in AAVE.
Second, the AAVE token is linked to the governance of the eponymous protocol. Holders of the cryptocurrency can discuss and vote for Aave Improvement Proposals (AIP) to improve the protocol. Some examples of proposals: changing the parameters of the Aave money market, the management of reserve funds... Like many governance tokens, 1 AAVE = 1 vote.
AAVE further decentralizes DeFi applications by adding a brake to the ecosystem to mitigate black swan type events.
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The challenges of Aave
One of Aave's challenges is the over-collateralization of loans. Unlike the traditional financial system, there is no "credit score" system to determine whether the borrower will be able to repay their loan with interest.
So, unlike loans offered by banks, which require little collateral, an Aave user must lock up an amount in crypto that is much higher than the amount they wish to borrow.
Such limitations make Aave an inefficient system. Aave requires its users to lock up a large amount of capital, making it less accessible to small investors. While this is done to protect creditors, this system naturally limits the size of Aave's aggregate debt.
To conclude
Decentralized money markets like Aave or Compound are paving the way for an open and transparent financial system. Aave is an interesting DeFi project that allows cryptocurrency users to borrow and lend funds transparently.
The AAVE token also looks promising. It allows its holders to vote for changes to the Aave protocol. And to protect the protocol from black swan type events.
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