What Is AAVE in Crypto & How Does It Work?

While the cryptocurrency market features many differences compared to the more traditional financial markets, they have many things in common. For instance, those with the means can profit by allowing others to borrow some — for a price.

What Is AAVE in Crypto & How Does It Work?

Disclaimer: This is for informational purposes and is not meant to serve as financial or investing advice.

If you find yourself in abundance within the cryptocurrency market, or if the shoe is on the other foot and you need additional resources, this is the article for you. Keep reading with Pluto for ideas on navigating the lending and borrowing world, which is at the heart of AAVE.

What Is AAVE in Crypto?

Aave is a decentralized cryptocurrency lending platform allowing users to lend and borrow currencies. It runs on the Ethereum blockchain and was founded by Stani Kulechov. AAVE is the platform’s native token.

The Aave protocol is an open-source lending protocol that works similarly to other DeFi protocols (Decentralized Finance protocols) in the crypto ecosystem, such as Binance, enabling trading, staking, NFTs, and crypto loans on the Ethereum network.

It can be easy for beginners to confuse the Aave platform with AAVE. Just remember Aave = platform and AAVE = token.

Initially called ETHLend, AAVE’s initial coin offering (ICO) was a staggering $16.2 million in 2017. Of course, the total value of AAVE coins has fluctuated since then.

AAVE vs. aTokens

The platform issues two tokens: AAVE tokens and aTokens.

aTokens interest-bearing tokens are minted upon deposits. But they don’t last long. They’re destroyed once redeemed. Borrowers accrue interest through them. The AAVE tokens are more beneficial. Why? Because if you borrow AAVE, there’s no fee for the loan.

What Is Aave Used for in Crypto?

It uses smart contracts (programs stored on a blockchain that begin functioning when predetermined conditions are met). These contracts require overcollateralized loans, which mandate that users deposit crypto worth more than the amount they seek to borrow.

Here’s how it works: Lenders deposit their funds into a liquidity pool, and borrowers pull from those pools. The lender can also determine how the tokens are transferred or traded.

How Does Aave Work in Crypto?

The Aave word has multiple corners, including lending, borrowing,  flash loans, and liquidation.

Lending Assets With Aave

Connect your digital wallet to the platform if you want to lend your crypto assets on Aave. (A wallet is where you store your passwords, which are also called “keys,” and your coins.)

Next, find which currencies support deposits. Does Aave support the currency you want to use? It’s important to know that deposits offer interest paid out in the same currency deposited. So if you lend tokens of Ether (ETH), the interest you generate will also be paid to you in Ether.

We used Ether as an example because it’s one of the currencies supported on the Aave exchange. Others include:

  • Dai (DAI)
  • Aave (AAVE)
  • U.S. Dollar Coin (USDC)
  • Tether (USDT)

Many of these are stablecoins, distinct digital assets tied to the fiat currencies (such as USD) that traditional financial institutions use for standard operations.

Once you deposit the cryptocurrency you’d like to lend, it becomes a larger liquidity pool. This is where borrowers come for the assets.

Remember we talked about the interest you’ll earn? Those borrowers pay interest, which goes back into the pool. A percentage of that is then paid out to the borrowers. Anytime you want out, you can withdraw your funds along with the interest you’ve earned.

Here’s a quick note: Remember that this is all decentralized (meaning no established central authorities like governments or banks can interfere). That means all transactions occur on the blockchain, and everyone involved in the lending/borrowing process will have to shell out network fees. (They’re called “gas fees.”)

Borrowing Assets on Aave

As mentioned above, it involves smart contracts, which require overcollateralized loans that mandate users deposit crypto worth more than the amount they seek to borrow. The silver lining is that you can earn interest once your collateral is in place, sitting in a liquidity pool. (Cha-ching!)

Once that is completed, select which currency you want to borrow. They’re all different, so the exchange will then calculate how much you can borrow based on your collateral and the value and volatility of the currency you’re seeking.

Follow the prescribed steps, and the currency will appear in your crypto wallet. But now you might wonder how soon you need to repay the loan. The answer: There is no time limit. Take as long as you want, but repay with the same currency you borrowed.

Aave and Flash Loans

Flash loans are financial agreements where you borrow currency with the promise to repay it (along with a fee of 0.09% ) within the same transaction. (In other words: repaid quickly.) Another big difference is that no collateral is required.

Why would someone do this? For example, you may want to take advantage of a price difference regarding the same asset on different exchanges. This is known as arbitrage, a way to make a quick profit.

Aave and Liquidation

Sometimes the value of the collateral you deposited for the loan sinks below a certain loan-to-value (LTV) ratio. When this happens, the exchange may automatically reimburse part of your loan through liquidation.

(And by the exchange, we technically mean people known as “liquidators.” They repay the loan and collect that collateral along with a bonus of 5%.)

Up to half of your collateral will be sold off to bring that LTV number back within the defined limits of the original loan agreement.

What Are the Risks of Aave in Crypto?

With Aave, including buying AAVE,  you open yourself up to the possibility of peril, which includes a lack of insurance, volatility, and liquidation risks.

We’ll go over them below in more detail.

Lack of Insurance

There’s no insurance on this exchange. That means nothing is protected. What happens if funds are sent to the wrong address? Or lost?  In the end, nothing. You have to eat that loss. So tread carefully.

Crypto Volatility

The crypto market is very volatile. That means values can skyrocket or sink in the blink of an eye. That creates the risk for you to lose a lot of money. Remember the collateral you deposited? Those funds can’t be touched until your loan is completely repaid. And if the value of your collateral drops like a stone, the liquidations set in, and you part with more than you planned.

Liquidity and Liquidation Risk

We earlier covered liquidity and how that can mean losing some of your collateral if its value drops too far. And if you’ve deposited currency and the liquidity sinks too low, you would be forced to wait until other users deposit more funds before you could withdraw.

What Can We Expect in the Future of Aave in Crypto?

It’s hard to tell. Some laud it, while others urge caution. For example, AAVE tokens have not made gains year-to-date and were down 31% as of November 2022.

But as we said, there are predictions on both sides. For example, WalletInvestor offers a bearish forecast, while DigitalCoinPrice has a bullish outlook. (Bullish refers to a belief that prices will rise, while bearish feel prices will fall.)

Remember our warning that the crypto market is very volatile and thus unpredictable. If you’re interested in Aave, it’s worth doing more in-depth research.

The Bottom Line

If you’re looking to borrow or lend cryptocurrency, Aave is an option worth exploring. But due to the potential peril, including no financial protection and a volatile market, you’ll want to ensure you understand the risk vs. reward ratio before making a final decision.

When it comes to succeeding in the crypto market, you’ll want someone to talk to with the knowledge and experience to guide you in the right direction. And perhaps the Pluto team is the right fit for you.

Pluto is an investing app that helps you automate investing in stocks and cryptocurrencies by building a portfolio of strategies or rules for when to buy and sell.

With us, you can quickly build a portfolio of strategies to watch your investments and make better decisions with your own rules like “if bitcoin (BTC) dips below $20k, then buy.”

If you enjoyed this blog entry, please be sure to give our full blog and YouTube page a look, as we cover a wide variety of topics that can arm you with the knowledge to grow as a crypto investor.


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