After watching a video on the Arbitrum (ARB) Level 2 chain/network (and, more specifically, the Aave grants DAO), I decided to take a look at Aave. The project's documentation (docs.aarve.com) describes it as follows:
"Aave is a decentralised non-custodial liquidity market protocol where users can participate as suppliers or borrowers. Suppliers provide liquidity to the market to earn a passive income, while borrowers are able to borrow in an overcollateralised (perpetually) or undercollateralised (one-block liquidity) fashion."
OK, but what is a liquidity pool?
According to Sensorium XR ...
"A liquidity pool is a smart contract containing large portions of cryptocurrency, digital assets, tokens, or virtual coins locked up and ready to provide essential liquidity for networks that facilitate decentralized trading.
A decentralized exchange relies greatly on liquidity because of the regular rate at which transactions are made on their network; for this reason, decentralized exchanges need to be connected to liquidity pools that can help maintain a steady functional network that doesn’t delay transactions made by traders.
In crypto liquidity pools, digital assets are locked and ready for exchange. Liquidity pools serve as a digital asset reserve that can provide liquidity to help speed up transactions for decentralized finance (also known as DeFi) markets such as decentralized exchanges (also known as DEX)."
OK, so liquidity pools contain liquid cryptocurrency assets. Gotcha, but what's a liquid asset? To Investopedia we go:
"A liquid asset is an asset that can easily be converted into cash in a short amount of time. Liquid assets include things like cash, money market instruments, and marketable securities. Both individuals and businesses can be concerned with tracking liquid assets as a portion of their net worth. For the purposes of financial accounting, a company’s liquid assets are reported on its balance sheet as current assets."
So, if I understand this correctly, Aave is a token for use in fund pools with a lot of crypto available to them for fast and highly-available exchanges/trading on decentralised exchanges primarily focused on loans. OK, fine, but what's so special about Aave (as opposed to some other "liquidity market protocol", particularly a non-Ethereium-based one, if such a thing exists)? In short, why should I care? According to the FAQ docs:
- The codebase is open-source.
- Aave has undergone a security audit.
- Aave has an API, which allows for building custom applications and UIs for interacting with it (trading).
- Aave works on proof of stake (PoS).
- Using Aave allegedly reduces gas costs "by around 20-25% across the board", according to the docs.This may be because it runs on Avalanche (AVX) and Polygon (MATIC) networks, in addition to the Ethereum (ETH) mainnet.
- Aave allows borrowers to choose between fixed and variable interest rates (but not both simultaneously).
Apart from the reduced gas fees, what advantage any of this offers over other options, I don't know from reading Aave's documentation. I've already lost interest in that site at this point. Maybe Binance can shed some light on it:
- Aave is a decentralised, peer-to-peer protocol.
- Like other DeFi platforms (for example, Compound), deposits are tokenised. They accrue interest in real time.
- Aave supports over fifteen different assets, many of them stable coins (and even fiat).
That all looks very impressive, but how does Aave compare to something like Compound Finance (COMP), to use Binance's example?
- Aave supports flash loans "borrowing for a short period without having to put up any collateral". That could be a good thing for the borrower, but it could be very bad for the lender.
- Compound doesn't support flash loans.
- Aave has no KYC requirements, but neither does Compound.
- The collateral requirements for regular loans on Aave are lower than on Compound.
- On both networks/platforms/services, interest rates "are determined by the market; this means that the rates can fluctuate based on the demand for the assets being deposited or borrowed". However, Compound offers slightly higher interest rates. "Which platform offers the better interest rates depends on the asset being deposited or borrowed. However, Compound generally seems to provide slightly more competitive interest than Aave."
To answer the "why should I care?" question, the answer seems to be "you shouldn't, really" (at least as far as Aave is concerned). From the little I've read on both Aave and Compound, Compound seems to be the better option. I will have to investigate further, since the Exodus wallet supports using it and I know very little about it.
Disclaimer: I have not read the Aave technical paper (linked in "Resources"), since I'm not that interested in the project. I've only skimmed the first couple of paragraphs in the "Introducing Aave V3" ARC (also linked below).
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