What on earth is AAVE? How did it grow from literally nothing to $3Billion in less than a year? What are the causes for it’s astronomical rise? Let’s understand how it all happened.
The initial version of AAVE which is one of the popular lending protocols in decentralized finance came into existence in 2017. The project was known earlier as ETHLend, was started in Finland by Stani Kulechov. Stani understood the potential of Ethereum & how the future of smart contracts and decided to build a peer to peer protocol.
The first version of ETHlend was deployed on the Ethereum blockchain on 2017. It started gaining traction among the early adopters in the ethereum community. Stani saw the potential of the decentralized lending and decided to raise money via an Initial Coin Offering (ICO) to fund further for the platform’s development. Through the ICO, ETHlend managed to raise US $16.2 Million and the fund allowed Stani to hire developers for upgrading the technology of the platform.
Over the years, the team realized that the P2P lending model had certain drawbacks that would cripple the platform’s growth in the long run. In the P2P model, the lending is managed by earlier versions of smart contracts and were inefficient.
Simultaneously, around the same time projects such as Compound and Uniswap were employing another model known as Peer to Contract (P2C). The P2C model is based on a contract with Pooled funds that can be instantly used by the users of the protocol. This eliminates the wait time necessary to find a counter party and makes the process of interacting with the decentralized protocol smoother.
Taking inspiration from this model, the ETHland team decided to change the functioning of the protocol to the Peer to Contract model. They also changed the name of the protocol from ETHland to AAVE.
In the latest version of the AAVE protocol, AAVE users become depositors by lending the cryptocurrency to borrowers who need funds thereby earning a percentage as interest on them. In turn supplying liquidity to the protocol. AAVE also offers a stable interest rate that makes it affordable to many users.
Users supply a stable coin such as DAI and start generating interest on the amount lent. The interest rate is determined by the ratio between the supplied and borrowed DAI on the protocol. The supplied DAI can then be used by borrowers after supplying a collateral such as ETH or any supported crypto asset.
The standard loans across the AAVE protocol are over collateralized, meaning the value of supplied collateral is higher than the amount that can be borrowed. This protects the protocol from being undercollateralized and not being able to repay the depositors incase the borrower fails to pay.
Lenders on the AAVE protocol also get rewards such as ATOKENS whose value is dependent on the value of the underlying tokens. The balance of the ATOKENS represents the deposited amount plus the interest accrued over the tenure. As the interest is compounded, the value of the ATOKEN in the account will increase.
You can even send an ATOKEN to someone during this tenure, the balance of the token will keep increasing automatically in their wallet depending on the interest accrued.
Flash loans is a feature of AAVE that allows you to borrow any available amount of assets from a designated smart contract pool without the need to put up a collateral upfront. The only catch is that the amount has to be borrowed and paid up within the same blockchain transaction. Failing which, the transaction will roll back This is helpful in trading mechanisms like arbitrage, collateral swapping and self-liquidation.
With newer DeFi protocols and Yield farming coming into practice, the total value locked in AAVE during APR 2020 was around $40 Million and rose to over $3 Billion in mid January 2021.
AAVE also raised funds from various Venture Capital firms. UK’s Financial Conduct Authority (FCA) also issued Electronic Money license to AAVE paving way for the possibility of AAVE becoming an authorized gateway/bridge between cryptocurrencies and traditional banking systems.
Late last year, AAVE also introduced something called AAVENOMICS that allowed token holders to participate in the protocol governance. Token owners can vote on a variety feature upgrades in the Version 2 of AAVE, the way the protocol functions and decide on the future of the protocol.
Some of the noted features of AAVE Version 2
- Collateral Swap: Users can swap their collateral from one token to another should they feel the need to swap. Collateral Swap is made possible by flash loans.
- Batch Flash loans: Token hodlers can now borrow multiple tokens in one go.
- Debt Tokenization: Borrowers will receive ‘Debt Tokens’ that are proportionate to the amount availed by them and in turn can power a Credit rating system on the platform.