Posted on Apr 06, 2022Read on

Aave Overview

What problem is the protocol solving?

AAVE allows anyone to loan/borrow crypto in a trustless, permissionless, non-custodial way. Unlike in the TradFi system where the bank earns a premium on your assets, users can both maintain ownership of their assets and earn passive income when lending. Aave also allows those who are traditionally unable to qualify for loans to have access to borrowing due to its decentralized nature. Lastly, Aave addresses issues within Defi lending like offering stable interest rates and offering flash loans for sophisticated users/developers. 

Describe the protocol, how it works

AAVE works by allowing pool to peer lending where depositors put their assets in liquidity pools (LP) and then borrowers can borrow from these pools. When depositing funds into an LP, you receive “aTokens” in return which the user will receive a portion of the interest gained from the LP and flash loans and can be redeemed for your collateral at any time. In V2, LPs consisted of many different underlying tokens compared to in V3 where “E-Mode” maximizes efficiency by grouping assets correlated in price and where “Isolation Mode” will allow AAVE users to add new assets without exposing the general LPs to the risk of the asset. Three main values determine risk on AAVE, Loan to Value ratio, Liquidation Threshold, and Health Factor. The difference between the LTV and Liquidation Threshold is the safety cushion for borrowers and leads to the calculation of the user's health factor (please see formulas below). 

Liquidation Threshold Formula

MaxLTV Formula

Health Factor Formula

In the event that the user's health factor drops below one, a liquidator can repay up to 50% (100% in V3) of the borrowed amount and receive a liquidation bonus for doing so. Users can also use flash loans that allow users to borrow without collateral as long as the original amount plus an 0.09% fee is returned by the end of the transaction (or block).

In V3, AAVE also has enabled Portal which allows assets to flow between markets on different networks via approved bridges. 

Explain the token, tokenomics, how it accrues value

There will be a fixed supply of 16M Aave tokens minted with 3M out of the 16M AAVE tokens being allocated to the Aave Ecosystem Reserve. Users can stake their AAVE token for an initial reward of 550 AAVE per day which is split between all stakers. That allocation is subject to change as it is voted on quarterly or until the supply of AAVE tokens runs out. If a user wishes to unstake, there is a 10-day cool-down period before a 2-day period begins where you can unstake your tokens. If the user does not unstake their tokens in the 2-day window, the cooldown period restarts. Staked tokens are used to protect against shortfall events where up to 30% of the AAVE locked in a Safety Module are auctioned on the market to be sold against the assets needed to mitigate the occurred deficit. The AAVE token itself is a simple governance token that enables holders to vote on protocol, risk, market, improvement, and incentive policies. The AAVE token is deflationary like Bitcoin since it has a fixed supply of 16M tokens. Currently, 85% of AAVE tokens are currently in circulation with roughly 21% of eligible tokens being staked.  With deflationary assets, if demand consistently increases then so should the price since supply is fixed. The AAVE token is live on Ethereum mainnet and AAVE markets are live on several other EVM compatible chains.  

What market does the protocol compete in?

The Aave protocol competes in the overcolatorized Defi lending market primarily on the Ethereum blockchain but also on other EVM compatible chains such as Avalanche, Polygon, Arbitrum, Fantom, Harmony, and Optimism. Aave’s most popular competitors that offer collateralized lending are Compound, C.R.E.A.M., Alchemix, and more. 

If you were to prepare a financial statement for this protocol, what would be the top 5 metrics to include.

  1. Revenue & Earnings
  2. Total Value Locked (TVL)
  3. Liquidity 
  4. Number of unique users
  5. Total outstanding debt