Aave is an open-source, non-custodial money market platform that provides various debt-based products in a decentralized manner. As a DeFi platform built on Ethereum, Aave accommodates ETH, various stablecoins such as DAI and USDC, as well as various ERC-20 tokens from the decentralized finance ecosystem. Aave protocol users can earn interest by depositing digital assets into liquidity pools, and can also borrow assets in stable rate loans, variable rate loans, and flash loan forms. If a user deposits tokens into Aave's liquidity pool, they will receive a corresponding amount of aTokens, which represent the interest-bearing tokens the user holds. If borrowing from Aave, users must provide enough collateral in another asset to support the loan. This ensures the safety of funds in the protocol to prevent defaults or declines in collateral value.
On Aave, stable rate loans have stable interest rates over time, similar to traditional bank loans. Variable rate loans have dynamic interest rates that fluctuate based on supply and demand. As with many DeFi lending platforms, a key element of Aave's market mechanism depends on over-collateralization, as long as there is enough collateral to support stable and variable rate loans, they can remain open. Flash loans are a novel and experimental lending mechanism that does not require collateral but must be repaid within a single Ethereum block. Flash loans are designed for developers or those with some technical knowledge.
In managing its innovative money market, the Aave protocol adopts a fully decentralized autonomous organization (DAO) governance model, where holders of AAVE governance tokens securely manage and develop the platform through voting and staking tokens. AAVE token holders are responsible for proposing and voting on changes to the platform, collectively managing risk and return leverage in the Aave money market. Although Aave initially launched with the native LEND token in 2017, the first Aave improvement proposal in its DAO approved the migration of the token to the AAVE token, which was executed in September 2020.
Tokens
Aave manages debt in its system using excess collateral and liquidation systems. By depositing tokens into Aave, you can provide liquidity for Aave's token pools, triggering the automatic minting of aTokens. These ERC-20 tokens are pegged 1:1 to the value of the underlying asset and are a requirement for the liquidity you provide. aTokens earn interest in real-time directly in your wallet, which fluctuates with borrowing demand and liquidity supply. By holding aTokens, you can continuously earn interest on deposited assets, and you can redeem them at any time. aTokens also give holders the right to a certain percentage of fees from Aave's Flash Loans mechanism.
Each aToken is based on a single cryptocurrency asset. Users depositing ETH into Aave will mint aETH tokens, while users depositing DAI into Aave will mint aDAI tokens. AETH and aDAI will earn different interest rates depending on the borrowing supply and demand of their respective underlying assets. The more an asset is used, the higher the interest rate and the greater the risk. The real danger is when the utilization rate approaches 100% and liquidity is exhausted, which can lead to a shortage of collateral in the system as the value of collateral is insufficient to pay off debts or meet users' desire to withdraw collateral.
Liquidation
On the Aave platform, except for flash loans, loans require excess collateral, which means that the locked collateral value must always be higher than the loan value. For over-collateralized loans, borrowers are responsible for ensuring that the value of their collateral does not fall far below the minimum level, otherwise they run the risk of being liquidated. When a loan is liquidated, a portion of the collateral is automatically sold to repay some of the debt, as well as any fines and fees.
Although painful for borrowers, liquidation ensures the effectiveness of the Aave platform by expelling unsustainable loans from the system - helping to ensure that other users have enough liquidity and maintain balance on the platform. If liquidation events are not sufficient to maintain liquidity in the system, AAVE tokens locked in the safety module will be auctioned on the public market to restore liquidity to the platform.
Safety Module
In a demonstration of DeFi composability, Aave integrates with other decentralized finance platforms such as Balancer to create novel financial products and mechanisms. Aave's safety module is a designated liquidity pool on the Balancer platform, where AAVE token holders can lock their tokens to earn more AAVE tokens and vote on protocol decisions. AAVE tokens locked in the safety module earn fees from the Aave protocol to ensure its liquidity mechanism and serve as a last resort collateral liquidity in the event of a deficit event with high risk on Aave.
Maintaining liquidity through over-collateralization is key to Aave. Without liquidity, there is no new borrowing. In the case of a deficit event, up to 30% of AAVE tokens locked in the safety module are sold to provide more liquidity for the protocol.
In addition to platforms like Uniswap, Balancer and Curve, DeFi protocols like Aave offer a new financial ecosystem that has no intermediaries and is maintained fairly by the user and token holder community. It not only encourages token holders to increase the value of their tokens through proper protocol management, but also encourages them to prioritize their security and protection. On Aave, responsible governance goes hand in hand with providing actual collateral to the system. Aave's lending system is not only guaranteed by the decisions of AAVE token holders, but also by the value of the AAVE token itself, adding an extra layer of liquidity guarantee.