- Aave is a decentralized finance (DeFi) lending network mostly based on the Ethereum blockchain.
- It enables rapid cryptocurrency loans using other cryptocurrencies one holds as collateral.
- It also enables users to earn money by lending out their cryptocurrency.
What Is Aave?
Users can borrow and lend cryptocurrency on the decentralized Aave platform. Aave automates the process using smart contracts, which include predetermined rules for how money is disbursed, how collateral is handled, and how fees are calculated.
Aave specializes in overcollateralized loans, so customers will have to put up more cryptocurrency than they want to borrow. This safeguards lenders from suffering financial losses as a result of loan defaults and enables the Aave protocol to sell the collateral if its value falls too low.
How Does Aave Work?
- Aave makes use of ‘smart contracts,’ which are computer programs that calculate lending terms, gather deposited security, and disperse the bitcoin being borrowed.
- Aave can operate independently of a third-party mediator thanks to smart contracts.
- With Aave, users can deposit cryptocurrency into the platform and earn interest that is disbursed by borrowers.
- Aave provides liquidity pools into which users may deposit their crypto assets, and those crypto assets are lent to borrowers instead of directly connecting lenders and borrowers.
Aave Lending
Users can go through a list of assets that enable deposits and connect a digital wallet to the site to lend cryptocurrency on Aave. A fixed annual percentage yield (APY), which is paid out in the same asset as the deposit, is offered by deposits.
For instance, interest is paid out in ETH if a user deposits Ether (ETH).
Aave Borrowing
Once money has been placed, customers can look for supported crypto assets to borrow, and Aave will figure out how much they can borrow for them. Aave automatically determines the available amount based on the value of the deposited cryptocurrency, the asset’s value, and its volatility because each crypto asset has unique properties.
Users can then confirm the transaction and the selected cryptocurrency will be deposited into their associated wallet.
The value of the assets deposited will always exceed the value of the crypto loan because all Aave loans are overcollateralized. Aave restricts borrowing to prevent lenders and liquidity providers from suffering financial losses if the value of the loan collateral declines. A higher-volatility collateral will have a lower LTV than more stable assets.
Risk Of Aave
- Liquidation risk
If the pledged collateral, such as the volatile cryptocurrency ETH, sees a significant value decline, the ETH may be liquidated. This is a highly unfavorable outcome because it indicates that ETH is selling off following a price decline.
- No insurance
Users’ cash is not safeguarded because Aave does not offer insurance on its site. There is no Federal Deposit Insurance Corp. (FDIC) insurance; therefore, lost funds or cryptocurrency sent to the wrong address won’t be refunded, just like with other decentralized crypto platforms.
Conclusion
Users can borrow and lend cryptocurrency on the decentralized platform. Aave automates the procedure using smart contracts. It specializes in overcollateralized loans, which demand that borrowers deposit cryptocurrency worth more than they want to borrow. This safeguards lenders from losing money as a result of loan defaults and gives the option to sell the collateral if its value falls too low.
