Aave Protocol is a Defi lending protocol that allows users to lend and borrow a variety of cryptocurrencies using both fixed and variable interest rates.

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Aave was originally launched as ETHLend, a blockchain-based peer to peer lending protocol founded in 2017 by Stani Kulechov and co-founders. The project then raised funds via an initial token offering in 2017. ETHLend was later re-branded Aave in late 2018, introducing new features compared to the original platform. Aave has quickly emerged as one of the top Defi platforms in recent months.

Aave's market size at the time of writing
Aave’s market size at the time of writing

Aave’s main difference from other Defi platforms is the ability to offer unsecured loans. The protocols shares other features of DeFi protocols such as being open-sourced, and operates on a zero-margin principle.

How does Aave work?

Avve transformed its operating model from peer to peer lending to a model based on liquidity pools. On the Aave, lenders contribute cryptocurrencies to the liquidity pool. Liquidity pools are managed by previously programmed smart contracts. At the same time, in this same smart contract, a borrower can borrow from these liquid pools with collateral.

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These loans do not need to be matched individually, but instead will be matched based on the amount of the loan and mortgage. This allows for instant loan matching based on the characteristics of the liquidity pool at a specific time. 

The interest rate for both the lender and the borrower is determined by the algorithms.

For the lender, the interest rate will be determined based on the cost of funds – the amount available in a liquidity pool at the time of the transaction.

For the borrower, this rate will depend on the rate of return that algorithms set up to ensure the lender can withdraw money at any time.

In July, Aave introduced credit delegation feature that allows for unsecured loans. With credit authorization, depositors can delegate their credit lines to others. For example, John deposited an asset like USDT into Aave and delegated his credit line to Marry, who withdraws funds like ETH from the Aave Protocol. More about credit delegation and how it works can be found here.