What is Aave (AAVE)?
One of a number of emerging DeFi cryptocurrencies, Aave is a decentralized lending system that allows users to lend, borrow and earn interest on crypto assets, all without middlemen.
Running on the Ethereum blockchain, Aave instead is a system of smart contracts that enables these assets to be managed by a distributed network of computers running its software.
This means Aave users do not need to trust a particular institution or person to manage their funds. They need only trust that its code will execute as written.
At its core, the Aave software enables the creation of lending pools that enable users to lend or borrow 17 different cryptocurrencies including ETH, BAT and MANA.
Like other decentralized lending systems on Ethereum, Aave borrowers must post collateral before they can borrow. Further, they can only borrow up to the value of the collateral they post.
Borrowers receive funds in the form of a special token known as an aToken, which is pegged to the value of another asset. This token is then encoded so lenders receive interest on deposits
A borrower may post collateral in DAI, for example, and borrow in ETH. This allows a borrower to gain exposure to different cryptocurrencies without owning them outright.
Aave can also introduce additional features, such as instant loans, and other forms of issuing debt and credit that take advantage of the unique design properties of blockchains.
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Aave is a for-profit company founded in 2017 by Stani Kulechov and based in Switzerland. Kulechov was trained in law in Helsinki and started Aave while still a student.
The firm, originally named ETHLend, raised $16.2 million in an initial coin offering (ICO) in 2017, during which time it sold 1 billion units of its AAVE cryptocurrency - originally named LEND.
A remaining 300 million units of AAVE cryptocurrency were held for the Aave team.
ETHLend was different from Aave in that, instead of pooling funds, it tried to match lenders and borrowers in a peer-to-peer fashion. In 2018 ETHLend was renamed Aave, which means “ghost” in Finnish. ETHLend became a subsidiary of Aave.
Other products and services announced at the time included a trading desk to handle large trades, a game studio focused on blockchain games and a system to handle payments.
How does Aave work?
Aave is perhaps best described as a system of lending pools.
Users deposit funds they wish to lend, which are then collected into a pool. Borrowers may then draw from those pools when they take out a loan. These tokens can be traded or transferred as a lender wishes.
To facilitate this activity, Aave issues two types of tokens: aTokens, issued to lenders so they can collect interest on deposits, and AAVE tokens, which are the native token of Aave.
The AAVE cryptocurrency offers holders several advantages. For instance, AAVE borrowers don’t get charged a fee if they take out loans denominated in the token. Also, borrowers who use AAVE as collateral get a discount on fees.
AAVE owners can further look at loans before they are released to the general public if they pay a fee in AAVE. Borrowers who post AAVE as collateral can also borrow slightly more.
The data firm Nomics has a more extensive list of AAVE's features.
Flash Loans
Aave allows certain loans, called “flash loans,” to be instantly issued and settled. These loans require no upfront collateral and happen almost instantly.
Flash loans take advantage of a feature of all blockchains, which is that transactions are only finalized when a new bundle of transactions, known as a block, is accepted by the network.
Adding each new block takes time. On Bitcoin, that interval is roughly 10 minutes. On Ethereum, it’s 13 seconds. An Aave flash loan therefore takes place in that 13-second period.
The flash loan works like this: A borrower can request funds from Aave, but they must pay back those funds, and a 0.09% fee, within the same block. If the borrower doesn’t do this, the entire transaction is cancelled, so that no funds were ever borrowed.
As a result, Aave doesn’t take a risk and neither does the borrower.
A borrower may wish to use a flash loan to take advantage of trading opportunities or maximize profits from other systems built on Ethereum. It’s possible to swap different cryptocurrencies in an automatic way using flash loans to generate trading profits.
Note: Flash loans have been combined to execute attacks on lending systems built on Ethereum, sometimes successfully stealing hundreds of thousands of dollars worth of deposits.
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