The history behind what is now Aave is an interesting story in and of itself. Aave was born in Finland in 2017 under the name ETHLend. Now, when we think of Finland we do not think of it as the caldron for brewing high tech DeFi projects. Silicon Valley it ain't! But this demonstrates the beauty of DeFi projects over traditional FinTech projects as the former does not require large technical staffs nor huge amounts of capital at inception. Nonetheless, ETHLend was rebranded as Aave in 2018, and has developed into one of the leading lending protocols in the DeFi space.
At inception, ETHLend was based on a peer to peer model, which model quickly proved to be inefficient in the DeFi universe. The peer to peer system clearly took too much time to match borrowers with lenders at agreed upon terms. Aave, however, is based on a peer to contract model where the users of the system work with pooled funds that by contract can be instantly used. As such, a users wait time to find a counterpart in the system to agree on terms is eliminated thereby making the system more efficient than peer to peer systems.
So, how does it work? Aave 101: those who use Aave are either depositors or borrowers. The depositors provide the lending funds to the pool in return for interest. Borrowers pay interest on amounts they borrow from the pool receiving a lump sum of a specific asset in exchange. Depositors supply an asset to the pool and start earning interest based on the supply interest rate which is nothing more than a ratio between what is supplied and what is borrowed of the asset deposited. Borrowers may then use the supplied asset by providing collateral for the transaction. The system is protected from not being able to repay the depositors as the protocol calls for the supplied collateral to always be higher than the borrowed amount.
Depositors providing assets to an Aave funding pool receive aTokens in return (based on a 1:1 ratio of the deposited pool asset). The aToken is valued as the deposited amount into the smart contract plus accrued interest. An aToken is an ERC20 token and as such, the aToken is fully transferable which transferred value keeps increasing in the transferees account as interest is accrued in the system.
Unique to the Aave protocol is the availability for the borrower to switch between fixed and variable rates of interest for repayment. Likewise, the availability of Flash Loans (a loan which allows the borrower to borrow any amount available in the pool without collateral, provided the loan is borrowed and repaid in the same blockchain action - interesting, but well beyond the scope of this article) and Credit Delegation (which is nothing more than an uncollateralized loan made by lenders based on trust in the borrower - again interesting but beyond the scope of this article) all add to the Aave hype. Aave is so much more than a simple base lending platform which all adds to its allure.
I hope this article provided a clear and simplified exhibition into what Aave is and how it works. Please remember, I am merely an ordinary small investor who likes to share what I've learned through research into the Crypto World. I am not in any way a financial advisor and as such, do your own research before investing. If you enjoyed this article please like it, comment and/or tip. Feedback is always welcome here.