Welcome to the second series of PYMNTS on decentralized finance, also known as DeFi.
In the first series, we looked at what DeFi is, how it works, and the uses, risks, and rewards it brings.
See also: PYMNTS DeFi Series: What is DeFi?
In this series, we’re going to look at some of the best DeFi projects – decentralized exchanges, lending/borrowing platforms, staking platforms – and see exactly what people are investing in when they go looking for 5% returns. , 10%, even 20% or more APR.
One thing to start with is that in DeFi, success is measured in “total value locked” or TVL, which means how many people have invested in a project. The “locked” part is because there is often a wait before you can get the funds back – which can be devastating if you need the funds right away or if the price of a token crashes.
Today we are reviewing Aave, one of the best crypto lending/borrowing platforms.
Founded as ETHLend in 2017 by former Finnish law student Stani Kulechov, Aave was rebranded in 2020 and its popularity has grown rapidly. It’s typically #2 behind Maker for the most TVL in a DeFi platform, with $4.87 billion locked.
At its core, Aave works like most DeFi lending platforms: lenders deposit funds into liquidity pools in exchange for returns – interest – transaction fees and governance tokens. Borrowers post cryptocurrencies as collateral, typically in the 125% to 150% range and borrow funds in the form of stablecoins without losing possession of their original crypto. If the value of the collateral falls too low and a margin call is not satisfied, the assets will be liquidated to repay the loan.
So what sets Aave apart?
AAVE the token
Like most lending/borrowing platforms, Aave has a native governance token, AAVE, which has several uses. Users who deposit collateral in AAVE have higher borrowing limits and can get lower fees.
Additionally, lenders who immobilize assets receive “aTokens” in return – e.g. deposit DAI stablecoins, get aDAI tokens. Put ETH in a liquidity pool and get aETH tokens. While they can be used to grab your assets, they can also be locked onto other DeFi lending and staking platforms to earn more via yield farming.
Read also: DeFi Series: What is Yield Farming and Liquidity Mining?
Play well with others
Well, a couple of things. For one, it not only allows people to borrow cryptocurrencies, but it works with another DeFi protocol, Centrifuge, to allow them to tokenize real-world assets such as freight bills, bridging loans and trade receivables on the RWA market so that they can be used as collateral. . Although it’s not a big part of its business, it’s not a mainstream offering.
While Aave started on Ethereum like most DeFi projects, it is now spread across seven blockchains, including Avalanche, Fantom, Harmony, Polygon, Optimism, and Arbitrum, a Layer2 blockchain on top of Ethereum.
In the March 2022 version three (V3) update, Aave added a feature called Portals that enables cross-chain lending. “You could drop in [Ethereum] mainnet, but borrow from Polygon and repay on Avalanche — all under the hood,” Kulechov told CoinDesk during the launch.
In January, Aave launched Permitted Liquidity Pools to attract institutional investors with stricter regulatory compliance needs than individual investors. Aave Arc lending pools will only be accessible to businesses vetted and whitelisted by blockchain security firm Fireblocks to meet Anti-Money Laundering (AML), Know Your Customer (KYC) guidelines. ) and penalties.
Aave Arc is a first step in outsourcing AML/KYC services that it is increasingly clear that DeFi projects that want to keep customers legal will eventually need to adopt.
See more : DeFi platforms bolster anti-money laundering efforts to woo institutional investors
Another feature of Aave is unsecured flash loans. A Flash loan is largely only used within the DeFi ecosystem. It works like this: you take out a loan, use it, and pay it back in one transaction. Since Ethereum has a blocking time of 12-13 seconds, a borrower has that amount of time to use it and pay it back or the transaction is reversed.
How it will be used is built into the transactions, so for example you can borrow funds, use them to trade cryptocurrency to take advantage of different exchange rates on different exchanges, make the trades and repay the loans all in one action. These are often used for arbitrage opportunities and users can borrow large sums.
Flash loans can also be misused and become a problem, especially in exploit hacks. In July, for example, the blockchain security company CertiK reported that $308 million was lost in 27 flash loan attacks in the second quarter of 2022 alone.
On August 1, AAVE token holders voted to launch a new algorithmic stablecoin, GHO, which would be backed by a mixed basket of other cryptocurrencies. Deposit collateral (at an overcollateralization ratio) and a new GHO token is created. When redeemed, GHO tokens are burned.
While this is much safer than the arbitration mechanism that failed during the May collapse of the $48 billion Terra/LUNA algorithmic stablecoin ecosystem, it is still not as safe as a fiduciary reserve.
Related: Unbacked Stablecoin Collapse Lost $48 Billion; Crypto says “Let’s throw two more”
We are always looking for partnership opportunities with innovators and disruptors.