Aave review: how a decentralised lending protocol works

Aave is a decentralised lending protocol. It grew out of ETHLend, a project founded by Stani Kulechov in 2017, and was renamed Aave in 2018. It runs on Ethereum and several other networks.

Supplying and borrowing

• Users supply tokens to a pool and earn interest paid by borrowers.
• Borrowers deposit collateral and borrow other tokens from the pool.
• Interest rates change automatically with how much of the pool is borrowed.

Over-collateralisation

Loans are worth less than the collateral. Each position has a health factor that falls as the collateral loses value or the debt grows. Below a threshold, anyone can repay part of the debt and receive part of the collateral at a discount — a liquidation. This keeps the pool solvent without a bank. See Liquidation cascades.

Flash loans

Aave popularised flash loans: uncollateralised loans that must be borrowed and repaid within a single transaction. They are used for arbitrage and refinancing — and have also been used in attacks on other protocols.

The AAVE token

AAVE holders vote on protocol changes, and the token has been used in a safety module meant to cover shortfalls. Rules evolve through governance.

Risks

Smart contract bugs, oracle failures, sudden liquidations during price drops, and governance changes. Learn the basics in What is DeFi? and DeFi risks. The market is on the AAVE coin page.

This review describes the project's design and is not investment advice. Cryptocurrency prices can be highly volatile.