Lending crypto is a potentially lucrative activity for crypto investors, who can obtain high returns for contributing to lending pools. Depositing to lending pools also gives lenders access to obtain crypto-backed loans. To start lending crypto, you’ll need to create an account on a platform that supports this functionality, such as Aave. In this guide, we’ll take a look at what Aave is, how it works and how you can start using it to earn interest on your investments and lend and borrow cryptocurrency.
At A Glance
- Aave is a DeFi lending protocol that allows users to lend and borrow digital currencies.
- The lending process takes place without any intermediary since users directly deposit to lending pools from which other users can borrow funds from.
What is Aave?
AAVE is a decentralized finance protocol launched in 2017 by Stani Kulechov used for lending and borrowing crypto. At its birth, the platform used to be named ETHLend and its governance token, AAVE, used to be called LEND. At this stage the platform worked differently, allowing borrowers and lenders to connect directly for peer-to-peer lending and borrowing. After ETHLend became Aave, the platform now works by pooling funds from lenders into lending pools, from which borrowers can obtain assets, all the while protecting the privacy of all users involved.
Aave runs on the Ethereum blockchain and is completely open source, which increases the security of the platform. Users can participate on AAVE on both ends of the spectrum, using it to lend out crypto assets or take out a crypto-backed loan.
How Does Aave Work?
The Aave protocol is made up of multiple lending pools. Users link their crypto wallets to Aave in order to deposit assets into these lending pools and can also borrow assets from them. Each pool keeps a percentage of the assets as a reserve to mitigate volatility and enable lenders to withdraw their funds when they see fit.
When you deposit crypto to a lending pool, you generate earnings for contributing to the liquidity of the pool. Borrowers pay an interest rate for their loans which contributes to the lenders’ profit. Earnings will depend on several factors including the borrowing demand for the asset you are lending and its current available amount on the protocol.
Since the platform runs on Ethereum, you should keep in mind that completing these transactions comes at a cost in the form of transaction fees.
Aave supports 17 different assets for lending and borrowing including USD coin (USDC), Ethereum (ETH), ETHlend (LEND), Chainlink (LINK) and Decentraland (MANA).
Is Aave safe?
While lending crypto will always imply some risk, there are several factors that contribute to Aave being a safe option to take part in this activity. Starting off, Aave is completely open source, which means that its code is visible to anyone and can be easily monitored for bugs. In fact Aave has a Bug Bounty Program where users can earn compensation for reporting a bug, receiving up to $250,000 USD if the bug is critical. The protocol has also been audited.
Additionally, Aave is a non-custodial platform making it less vulnerable to threat. This means that the platform doesn’t hold your assets or private keys at any point. Instead, the safety of your assets is completely dependent on the user, since your crypto is stored externally in your own crypto wallet.
If you are concerned about your privacy, you’ll be glad to know that Aave, like other DeFi platforms, doesn’t require its users to submit documentation required by centralized platforms such as Know Your Customer and Anti Money Laundering documents. Users can start lending or borrowing seamlessly by connecting their ethereum crypto wallet and depositing funds, no onboarding process involved.
In order to lend out your crypto on Aave and earn interest, you’ll first need to connect a supported crypto wallet, such as Metamask, to the platform. Next, select the lending pool you want to deposit assets into and the amount that you want to contribute. There is no minimum or maximum amount of assets you can deposit to a lending pool, however if depositing a small amount, you should take into consideration how much transaction fees might eat away from your deposit.
When you deposit to a lending pool, you earn a share of the interests paid by borrowers loaning assets from the pool. The higher the demand to borrow the asset, the higher the yield you can obtain. Interest can be collected based on two different types of rates, stable and variable.
If you want to withdraw your assets from the lending pool, you can do so at any time provided that there is enough liquidity in the pool.
What about using Aave to borrow crypto? To borrow you’ll first need to deposit an asset as a collateral. Loans on Aave are overcollateralized, meaning that the amount of collateral locked up must be larger than the amount withdrawn. This contributes to protecting the lenders.
Once you have put up collateral, you can borrow out the asset of your choice from the Borrow section of the platform. The amount you’ll be able to borrow depends on the value of your collateral and the available liquidity.
Next, you’ll need to select either a stable or variable interest rate for your loan. Stable rates act as a fixed rate that can be re-balanced based on changes in response in the market. On the other hand, a variable rate is based on the offer and demand in the platform. Overall, a stable rate has less variation and can help you make better predictions to calculate future interests. However, you can switch from one to another as you see fit.
Finally, you must repay your loan (the borrowed amount plus interest) using the same asset you borrowed.
Aave also offers Flash Loans, which allow you to borrow assets without any collateral. So, what’s the catch? You must pay back the borrowed amount, plus interest and fees before the next block is completed, in other words, within a single block transaction.
Doing a flash loan will require you to build a Flash Loan contract that is able to execute and pay back the loan within the same transaction. If the loan isn’t paid back in a timely manner, the transaction will fail.
The AAVE Token
Aave also has its own token AAVE which is used for the governance of the protocol, allowing you to vote on AIPs. The AAVE token can also be staked within the DeFi platform.
Aave: The Verdict
Aave allows you to lend and borrow crypto easily, privately and securely. Lenders can earn a passive income through attractive APYs and borrowers can obtain funds simply by putting up collateral.