AAVE: Decentralized Crypto Lending at Its Best

June 21st, 2021
9 minutes read

AAVE is one of the biggest and most interesting DeFi lending apps in the Ethereum ecosystem. They started way back in 2017 as ETHLend. Then a rebranding in 2020 to AAVE. It’s a great place to lend your crypto and it has more features and complexity than most DeFi platforms.

This is a deeper dive into what AAVE is, how it works, and what they offer so you can decide if it’s a good platform for your money.

AAVE’s Beginnings

But the name was not all that changed at that time. AAVE was a standard CeFi based p2p lender like Mintos or VIAInvest. You could pick the loans you wanted to fund when it started as ETHLend.

AAVE, when it was ETHLend, raised $16.2 million in funds from an ICO of their ERC-20 token, called LEND. Now it’s the AAVE token, according to blockchain investment provider Bitcoin Suisse

As ETHLend, AAVE has been on my radar since 2017. You can see a detailed description of what ETHLend was as a CeFi lender but still using smart contract technology in this piece I wrote for my personal fintech blog in October 2017. After the first generation of blockchain-based lending at places like BTCJam and Loanbase that I refer to in this article, I did a deeper analysis of what ETHLend was. Looking at what it was helps guide us to the changes they have made and what they are now.

ETHLend was the first lender to use Ethereum’s smart contract technology to administer and enforce loans. This was a big innovation in 2017. Not only was no one doing it yet, but the idea of taking human error out of the equation of loan enforcement terms would be important for the huge DeFi lending markets we have today. What ETHLend believed, and why they evolved to become AAVE, is that the smart contract enforcement of the loans was the most important part of what they had discovered from doing crypto based loans.

This is a general trend in the transition to AAVE. More on the tech and less on people. And this lesser need to trust other people is a big advantage.

AAVE is Popular

When dealing with newer markets like DeFi, I don’t like brand new platforms. Some can offer amazing returns. But for those returns, you are their guinea pig trying out their system. Hacks into weak points in the algorithms and programs or exploits for individual gains do happen. This CoinMarketCap article outlines over $284 million lost in these types of attacks. Specifically the losses come from:

  1. Flash loan attacks. A special type of loan that some very tech savvy people use to take advantage of pricing differences in markets. Different points in the smart contract are manipulated to the trader’s advantage and other market participants are at risk of loss from it. This one just happened on Binance Smart Chain with the Pancake Bunny app for $200 million. If you don’t do flash loans, then this is not a risk for you.
  2. Flaws in Smart Contracts. If the smart contract backing the loan has a flaw in it, then it can be hacked and manipulated. Here’s an example. You could deposit one stablecoin (USDT) to lend and get repaid in another stablecoin (USDC). While rare, manipulating the price oracle (the way information is sent from the real world to the blockchain) means that you could cash out your USDC for more than its current $1 price if the oracle says USDC is worth $4.50 instead.
  3. Rug pulls and exit scams. This scam happened in March and cost $31 million dollars. The platform looks like it never intended to provide the services, only collect crypto deposits and steal them.

So am I telling you that all DeFi is risky? No, I’m not. There are risks here just like with every platform where you choose to make a p2p loan. What I am telling you is that you can avoid most of these problems by using already established DeFi apps. If millions of other people for billions of dollars are using these apps safely, then the app is probably safe for you too. Compound is one that I’ve discussed with the way it works with MyConstant. AAVE is another.

Apps with a long history and big assets under management are safer for your investment. You still have the risk of loss like with all investments. Yet, the counterparty risk, the risk of the platform itself being the problem with an app like AAVE are much, much lower.

AAVE is one of the leading lenders in the Ethereum ecosystem. Check out its market share numbers.

Aave marketshare in crypto lending is 44% based on unique users

AAVE is growing so fast, check out this graph from analytics firm, Dune Analytics. In 15 months, there are more than 60,000 users of this app.

total Aave users from January 2020 to April 2021
Courtesy of Dune Analytics

Total liquidity at AAVE is over $20 billion at the time of writing. You are not alone in using it.

Aave protocol providing 20,732,612,729.48 USD in liquidity

Its biggest market, which is the V2 lending market, is over $12 billion in loans, and its six biggest markets total ~$11 billion dollars. Three of the markets are stablecoins (USDC, DAI, and USDT). Two of the markets are in wrapped tokens (ERC-20 compatible versions) of BTC and ETH, and the 6th is in the AAVE token itself.

Market size of Aave liquidity by asset in the following order: USD Coin, Wrapped ETH, Dai, WBTC Coin, USDT Coin, Aave

How Does AAVE Work?

While AAVE does a couple of different things including allowing flash loans that we’ve discussed above, at their core they operate in the same liquidity pool style investment popular with other DeFi apps. Like other DeFi apps, you earn the stated rate on your money that you agree to but you do NOT get to choose your borrowers. Some coming from USD or EUR p2p lending platforms prefer choosing their own borrowers. We know the choice is both an advantage and a disadvantage. Choosing to match your own risk level is the advantage while waiting for loans to fully fund is the major disadvantage. With AAVE, your money goes to work right away.

DeFi lending is collateralized lending. So someone will deposit crypto and be able to borrow against that collateral but less than 100% of it.

Link Your Wallet

The common practice when using DeFi apps is that you have to link your wallet to the app so you can lend. Unlike CeFi apps like BlockFi or Coinloan, you don’t have the additional option of exchanging Euros for crypto. Here you must have the cryptocurrency already and it must be in an ERC-20 (Ethereum) compatible wallet. Then you link it and go.

Let’s look at my favorite stablecoin, USD Coin or USDC. Here are the stats on AAVE v2 utilizing USDC for loans.

Liquidity for USDC on Aave is 3.3 billion borrowed and 1.1 billion available liquidity

Due to its price stability, the maximum LTV (loan to value) here is higher than most other cryptocurrencies at 80%, meaning a borrower can borrow up to $80 for every $100 they deposit. They are currently paying 2.27%, which is lower than many platforms pay and the borrow rates are split into two categories: Stable and Variable. The stable rate is determined by algorithmic programs (like all AAVE rates) based on supply and demand in the app. And like the name implies, the rate stays constant for your loan. The variable rates change and can go up or down based on movements in the market. With a stablecoin like USDC, not much variation would be expected so the borrowing rate for the variable market is low at 3.31%. The total reserve is $4.4 billion with $3.2 billion borrowed and $1.1 billion liquid and available for additional borrowing or liquidations.

Your Best Bet May Be Lending Crypto and not Stablecoins on AAVE

As we have seen on other platforms, there are higher interest rates to earn on stablecoins like Tether (USDT) or USDC. There are only two reasons to lend your stablecoins here on AAVE instead:

  1. You want a true DeFi experience instead of a CeFi platform OR
  2. The stablecoin you want to hold is not available to lend on other platforms like True USD or the Gemini Dollar

Otherwise, you are better off earning a lower interest rate on a more volatile coin like Bitcoin or Ethereum. You can lend the Wrapped version (ERC-20 compatible) of these coins. WBTC or WETH currently pay 0.02% and 0.07%, respectively. These rates are low, however, these coins are volatile. They have a fixed or potentially fixed supply meaning you might be earning interest in a coin that retains its value better over time.

Comparison Time: AAVE vs a CeFi platform

Here is a table comparing some of the most important benefits of AAVE vs a CeFi platform like BlockFi or Coinloan.

PlatformAAVECeFi Lending Platform (BlockFi or Coinloan)
PrivacyYes, only wallet addressNo, full KYC required
Interest Rates on StablecoinsLowerHigher
Interest Rates on Cryptos (non-stablecoins)Lower, but many more optionsHigher but few options for coins to lend
Control of your coinsYou controlThey control – you send your coins to them
Enforcement of your Smart Contract based loanAlgorithmic and automaticSome programmed and some company enforced
TransparencyHigh, near total. Stats available hereLittle
Liquidity Pool Style InvestingYesYes
Diversification from EuroYesYes
Investor Protection80% LTV max, collateralized70% LTV max, collateralized
Who is EligibleAnyone w/ ERC-20 walletMost but some restrictions
Can Exchange Fiat for CryptoNoYes
Has Native TokenYesCoinloan Yes, BlockFi No

When looking at this table, the biggest issue across a couple of features and benefits is the issue of control. You control your crypto, your wallet, and your privacy when you use a DeFi app like AAVE. For some, this is the only issue that matters. If how much interest you can earn is the only thing that matters, then you have a decision to make. Do you take the higher interest at a CeFi platform like BlockFi or Coinloan BUT you have to trust them to return your money to you? Or do you take a lower rate and maintain the control? No trust is required.

Conclusion

For those looking to make the jump to a DeFi lending platform from CeFi lending platforms of Euros or cryptocurrency, AAVE would be a great place to start. There are many options and many cryptos you can lend, all by linking your wallet and putting your cryptocurrency to work right away.