What is Aave? The Grandpa Version.
What is AAVE?
Let’s say you want to buy a car. You don’t have the money to buy a car. You go to the bank to ask for a loan to buy the car. You pay a 20% downpayment on the car. The bank pays the rest 80% of the amount. The bank charges you a fee called interest on the loan.
The bank act as a depositor too. It borrows the money from the depositors and pays a small fee, an interest on their deposits. The difference between the interest rates is the income of the bank.
A traditional bank works like this.
Aave is the crypto version of a bank. A decentralized application and protocol that allows people to lend and borrow cryptocurrency in exchange for a small fee. It is a people-to-people exchange with no intermediatory. It uses an algorithm to determine the fees and to match the borrowers to the lenders. It’s just the code that runs the entire system that replaces the bank as an intermediatory.
Aave also has an associated token. Based on the Ethereum blockchain. The holders of these tokens are allowed to vote on the changes made in the save system.
What is the need for AAVE?
AAVE solves two problems:
- The liquidity.
- Matching the borrowers to the lenders directly.
Aave uses a smart contract, which is a piece of code. It runs automatically to based on terms to operate the platform. Aave doesn’t depend on peers to match the borrowers and lenders. It uses the algorithm to connect both entities.
Lenders can deposit their money in a smart contract and earn interest. Similarly, borrowers can take money from a smart contract and pay interest. The liquidity is considered while deciding the interest rate by the algorithm.
What perks does AAVE come with?
A new system brings new perks too.
Overcollateralized loans.
You go to the bank asking for a loan. You mortgage your house for the same. The house is worth $100000. The bank pays you $80000 to keep itself safe from volatility. If you fail to pay the loan to the bank, the bank will kick you out. And keep the house or sell it to recover its money.
The bank lends you money because you will pay high interest on the loan amount. You purchase the house and transfer its ownership to the bank. You pay the rest of the money to the bank in the given period, and the bank charges you interest on the loan it has given you.
Well, crypto loans function differently.
If I want to borrow crypto, I have to be over collateralized. Suppose you want to borrow $100, you must pay the AAVE platform $120. Why would someone pay $120 For a$100 loan?
Suppose you need a $100 worth of USDC, a stable coin whose value is pegged with USD. You have Solana in your wallet, which you are willing to pay as collateral.
Now the value of the USD will remain stable due to pegging. But Solana is a volatile token. The value can change drastically. By the time you return the USDC and cash out your Solana, it has doubled in price. Now the cost of Solana became $200.
This algorithm works in both directions.
If the value of your Solana depreciates and becomes $100, the Aave algorithm will sell your Solana to recover its $100 worth of USDC. This way, investors never lose money.
Leveraged lending is possible.
Suppose you have $200 worth of Ethereum. You exchanged it for $150 USDC. With the $150 USDC, you buy more Ethereum and swap it. You receive $100 USDC again. After some time, the value of your Ethereum token has gone up by 2x.
You return all the $250 USDC you borrowed and get your $700 worth of Ethereum back. You just made a profit of $350. But if the price of Ethereum drops…You are fu*ked. Be Careful.
AAVE Loans are nothing like a traditional bank. According to the AAVE website:
You don’t have to return all the money till a specific date. You have overcollateralized the loan amount. You have to pay a part of it now and then. If your positions are safe, you can borrow for an undefined period. The only condition is that, as time passes, the rate of interest will continue to grow.
Flash loans.
The AAVE USP. It’s the main feature. The flash loan allows you to take a loan of millions of dollars without collateral. The catch here is you have to repay the loan amount with the same token as borrowed. The loan has to be returned in the same block. That means the duration of the loan is approximately 13–15 seconds.
Why banks are creating friction in the adoption of decentralized systems?
Blockchain and cryptocurrency have the potential to take over the existing banking system. Nobody regulates the Aave system. It’s just the code that runs the entire system. Aave means Ghost. When you borrow and lend, you don’t know the other party. AAVE is disrupting the banking system of the world economies.
