Understanding Two of Aave's Key Technologies

By Michael @ CryptoEQ | CryptoEQ | 20 Aug 2024


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Intro

Aave is an open-source, non-custodial protocol for earning interest on deposits and borrowing assets. Started in 2017 under its original name ETHLend, 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. 

Aave has established itself as the leading money market in the cryptocurrency space. Its decentralized borrow-lending peer-to-pool model has demonstrated itself to be the most capital-efficient approach for DeFi users to earn interest on their deposits or to obtain immediate access to an asset's liquidity.

The Aave platform functions by allowing users to deposit their assets into a lending pool and make them available for others to borrow. In return, borrowers pay back their debts along with interest.

Flash Loans

A major innovation Aave has implemented into its functionality is a concept called ‘flash loans.’ While most crypto-based loans require over-collateralization, flash loans are the only undercollateralized loans. In fact, flash contracts generally operate with no collateral at all so long as they're paid back within the same block in which they were originally loaned out.

flash loans

Flash loans on Aave are primarily targeted toward developers. Additionally, a cited use case for flash loans is generating profits between differing prices between exchanges. For example, many exchanges have slightly differing prices for various cryptoassets. By using flash loans, a savvy trader could take out a flash loan to buy a cryptoasset and then sell that same asset at a higher price on another exchange. Then, the flash loan can be paid back with the profit being pocketed. 

Rate Switching

Aave supports a unique feature for users called ‘rate switching.’ This allows borrowers on the protocol to switch between a fixed or floating interest rate. This gives the user enhanced flexibility to counter the high degree of volatility in the crypto economy and make long-term borrowing costs more easily recorded.

Aave uses an excel sheet/calculator that breaks down the daily fluctuations and processing of observed interest rates for Aave borrowing/lending markets.

Users can adjust their interest based on market projections. For instance, if a user anticipates higher interest rates, a fixed rate can be enabled to avoid increased costs. If the opposite occurs and rates decrease, a variable or floating interest rate can lower borrowing costs.

DeFi liquidation diagram Source: Delphi Digital

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Michael @ CryptoEQ
Michael @ CryptoEQ

I am a Co-Founder and Lead Analyst at CryptoEQ. Gain the market insights you need to grow your cryptocurrency portfolio. Our team's supportive and interactive approach helps you refine your crypto investing and trading strategies.


CryptoEQ
CryptoEQ

Gain the market insights you need to grow your cryptocurrency portfolio. Our team's supportive and interactive approach helps you refine your crypto investing and trading strategies.

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