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Overview

Aave is an open-source, non-custodial protocol for earning interest on deposits and borrowing assets. Started in 2017 under its original name ETHLand, Aave also enables uncollateralized flash loans designed to be integrated into other products and services. It raised $16.2 million in an Initial Coin Offering (ICO) to create a centralized peer-to-peer lending platform. It was later rebranded as “Aave,” which translates to “ghost” in Finnish. T Aave protocol was launched in 2020 and the model changed to a liquidity pool from P2P lending.

Strengths

Aave V3 has many new features and improvements. Flash loans present many interesting opportunities for arbitrage. Rate switching and leveraged strategies could attract fixed-income investors. Security audits have identified and addressed smart contract risks. Portal technology allows for a seamless flow between Aave V3 markets and different networks. And of course, active development is an inherently bullish characteristic. 

Weaknesses  

Ethereum congestion could drive gas prices to levels where using Aave becomes too expensive for users. The centralization of wealth in the top 10% of wallets could cause governance issues. Institutional holders could sell and cause volatility or affect liquidity. 

Opportunities 

DeFi and Aave are still in the infancy phase. The technology has been developed, but has not yet had mass adoption. It could still be a good time to buy in if you're bullish on the DeFi industry as the future of finance. The plans to develop a decentralized social media platform with Aave is bullish news as it would allow content creators to monetize their work and introduce new competition into the social media industry. Furthermore, new assets could be added to Aave markets over time to help fuel growth and adoption, and new use cases could be developed.

V3

Aave V3 was released in Q1 2022 and is the latest version of the borrowing and lending dApp. It introduces two new modes: the high-efficiency mode (“eMode”) and Isolation mode.

eMode will unlock higher utilization amongst similar category of assets, allowing for higher LTV of up to 95% to 98%. The E-mode feature maximizes capital efficiency when collateral and borrowed assets have correlated prices. A “category” refers to a set of assets pegged to the same underlying asset e.g. stablecoins pegged to USD, assets pegged to ETH, etc. Only stablecoins can be borrowed in E-mode in the beginning. This is similar to the Curve (CRV) model.

Each category will have its own customized risk parameters, including higher LTV ratios and lower liquidation thresholds. In the future, Aave V3 would be able to support up to 255 different E-Mode categories, to be determined by Aave governance.

Isolation Mode (discussed more below) will isolate risk for certain crypto assets deemed to be riskier/more volatile. Isolation Mode allows certain assets to be used as collateral only up to a certain debt ceiling and borrowers can only borrow stablecoins against the collateral. To list an asset as “isolated collateral,” it'll be required to go through a governance proposal before being listed.

By providing isolated assets as collateral, users can only borrow stablecoins that have been pre-approved by Aave governance. Besides that, borrowers are restricted by a specific debt ceiling, meaning they can only borrow stablecoins up to a fixed amount.

V3 launched with several other innovations including: 

• Deployment across many chains like Polygon, Avalanche, Fantom, Arbitrum, Optimism, and Harmony with Ethereum Mainnet release at a later date. 
• Cross-chain “portals” which facilitate bridge liquidity, allowing users to swap assets from any blockchain on which Aave is deployed
• A higher borrowing power if the borrow and collateral assets are both within the same highly correlated asset category (eMode)
• The listing of new collateral assets along with restrictions that limit potential protocol risk.
• The reduction of transaction fees by 20–25%.
• The introduction of specific features for L2 networks.
• Aave Portal allows users to seamlessly move assets across different blockchains.
• Aave Governance can delegate certain functions to teams or other individuals, maximizing decentralization.
• Capital efficiency optimization improves yield generation or borrowing power.
• Risk Mitigation adjustment improvements to heighten the security in the Aave protocol smart contract.
• Lower transaction costs. V3 gas costs have been optimized for all relevant functions. Gas costs have been reduced by around 20-25% across the board.
• Lucrative leveraged strategies through DeFiSaver.
• Rate switching allows borrowers to switch between fixed and floating interest rates.
• Moving funds between Aave protocol V2 to V3 requires you to withdraw funds from V2 and send them to V3. This transaction will incur gas fees.
• Risk management improvements added additional protection to the protocol by setting various risk caps and other tools.
• L2-specific features designed to improve user experience and reliability.
• Community contribution facilitates and incentivizes community usage through a modular, well-organized codebase.