Aave

Project history

Aave was founded by a Finnish lawyer with an interest in RegTech. It was one of the first crypto lending platforms, launched as ETHLend in 2017.

The project was funded by a successful ICO, raising about USD 17 million. The initial concept was to provide a decentralised platform to match borrowers and lenders peer-to-peer.

From the start, the company has been innovative and responsive to customer demand and opportunities in the market. Having experimented with various products and features, by late 2018 they have reimagined the lending platform entirely.

A new parent company was incorporated in late 2018 under the name Aave, the Finnish word for ghost. The new platform implemented a liquidity pool system, with lending rates determined by an algorithmic function. Version 1 of the new platform went live in January 2020, and Version 2 went live in December 2020.

Technology

With the launch of Aave V1 in January 2020, the original ETHLend platform was shut down.

The new platform operates liquidity pools where lenders can deposit tokens and earn most of the fees and interest paid by borrowers. Lending rates vary according to demand, by token, and whether the borrowing is at a partially fixed rate or a variable rate. The parameters that determine the rates are adjusted over time as market conditions for various tokens change.

The algorithm is calibrated so that it incentivises either more borrowing (lower rates) or more lending (higher rates) to drive the utilisation of the available liquidity towards the predetermined “optimal” level.

The loans are perpetual and are over-collateralised. The prescribed loan-to-value ratios and the liquidation thresholds vary according to the tokens’ risk. When the liquidation threshold is reached and the collateral has not been increased, the loan is liquidated. Safety reserves are in place to cover liquidity shortfalls due to bad debt, if any. Aave loans and deposits are represented by tradable tokens.

Originally launched on the Ethereum protocol, Aave is now also available on Polygon, and is actively targeting a multichain approach. Expansion is currently being explored to Solana, Avalanche and layer 2 scaling solutions.

Key people

The founder of Aave (originally ETHLend) was a young entrepreneurial Finnish lawyer Stani Kulechov, who had an interest in exploring how digital solutions can replace legal and regulatory functions, including those related to finance.

ETHLend (later Aave) was incorporated as a for-profit company, funded initially by an ICO, later by selling tokens held in treasury to VCs, including a $25 million VC round in October 2020.

Aave holds a portion of the tokens in treasury to fund future development, and it may use some of the platform revenues in future if this is approved in a token holders’ vote.

Supply model/Tokenomics

Aave’s predecessor ETHLend issued 1.3 billion LEND tokens via an ICO in late 2017. 75% of the tokens were available in the token sale. In 2020, the LEND tokens were converted to Aave tokens at a rate of 100 to 1, resulting in 13 million Aave tokens. An additional 3 million Aave tokens were created for the project’s reserve and protocol incentives.

Aave has migrated the governance of the project from the for-profit entity to the token holders.

Aave tokens accrue value through the portion of the fees and the spread collected by the protocol, as well as the discounts and improved terms Aave token holders are entitled to when participating in the platform.

The spread and fees collected by the protocol are used to buy Aave tokens in the open market, and Aave has committed to burning tokens. Ultimately the objectives of the Aave reserves are to grow the ecosystem and increase token value. Since governance is decentralised, token holders can drive decisions over the use of reserves.

Ecosystem reserves are intended to incentivise liquidity providers, liquidators, developers, and integrators with Aave tokens.

Additionally, a portion of the reserves is used as a liquidity backstop for the lending platform. Token holders can stake Aave on the platform to provide liquidity for the safety reserves that are used to cover liquidity shortfalls in the lending pools. The safety reserves earn a staking yield in Aave tokens from the treasury reserves, and up to a maximum of 30% can be slashed in case of a shortfall. Should the safety reserves be insufficient, Aave treasury reserves would be used to cover the remaining shortfall. There has not been a need for backstopping liquidity on the platform to date.

Key value drivers

As the leading DeFi lending platform, Aave’s success is tied to the growth of decentralised lending, which is, in part, fuelled by the dearth of yield in traditional markets. Solutions to offering uncollateralised loans and fixed rate products would catalyse significant further growth.

Delivering on Aave’s institutional platform, executing its multichain strategy to increase scalability and transaction speed, and reducing costs, should keep them ahead of the competition.

Lending platforms compete not just on the total liquidity they attract but also on utilisation rates, liquidity management, and collateral quality.
It is important to monitor the level of liquidations and bad debt, and how the breakdown of the platform’s revenues evolve.

As long as Aave remains the nimble, dynamic, and innovative project it has been to date, it is set to be a strong beneficiary of the trend towards decentralised finance.