Ghost in the Ethereum Virtual Machine: What Is Aave in Crypto?

Along with decentralized trading, peer-to-peer (P2P) lending is a popular service in decentralized finance (DeFi) with billions of dollars in locked digital assets. Although the number of decentralized applications (dApps) offering crypto lending continues to rise, the Aave protocol commands a leading position in this significant DeFi niche. 

Named after the Finnish word for "ghost," Aave often ranks as the go-to dApp for crypto lenders and borrowers, making it one of the moremost liquid platforms to secure a crypto loan. 

Aave’s history

Before Aave, software developer Stani Kulechov launched a P2P lending protocol called "ETHLend" on the Ethereum blockchain in 2017. Following a rebranding in 2018, ETHLend transitioned to the Aave protocol and continued expanding its services to DeFi traders. Initially, Aave only accepted the Ether coin as collateral, but it began welcoming more ERC-20 cryptocurrencies into its virtual vaults as it matured. When Aave upgraded to version 2 in 2020 and version 3 in 2023, it integrated other blockchains and offered more innovative products to traders, including flash loans, collateral swapping, and dynamic interest rates. 

In 2020, the Aave protocol introduced its native AAVE token, which functions as a governance token on Aave's decentralized autonomous organization (DAO). To give crypto traders even more options, the Aave team created a proprietary multi-collateral stablecoin known as GHO, which became available for minting following the v3 upgrade. 

How does the Aave protocol work?

Think of the Aave protocol as a decentralized money market where crypto traders directly borrow or lend virtual assets. Thanks to smart contracts—or blockchain-based programs that carry out pre-coded tasks—all of the transactions on Aave happen without third-party intervention. If traders want to take out a loan from one of Aave's pools, they deposit the accepted crypto collateral into a smart contract and receive virtual currencies in their connected self-custodial wallet. 

Borrowers must repay the loan plus interest to reclaim their collateral, while ensuring the market value of their collateral doesn't fall below a margin threshold. If the market price for a cryptocurrency used as collateral dips below this margin level, traders either need to pay off their loan or deposit more crypto to prevent a "liquidation." In a liquidation scenario, Aave seizes the collateral from a borrower to pay off the loan.

Aave loans are overcollateralized, meaning borrowers need to deposit more collateral than they intend to take out. This helps decrease the odds of liquidation. While overcollateralization doesn't eliminate the risk of liquidation—especially with volatile crypto assets—it gives borrowers buffer room and more time to prepare in a market downturn (aka bear market). 

On the lender's side, Aave lets crypto traders (or "liquidity providers") deposit cryptocurrencies into one of its smart contract loans. The assets deposited into these programs are the same cryptocurrencies borrowers take from the Aave protocol. To incentivize liquidity providers, Aave rewards lenders with a percentage of the interest collected on DeFi loans, including rewards in the form of Aave's AAVE token. 

Aave FAQs

What is the AAVE token?

AAVE is a DeFi token that uses Ethereum's ERC-20 standard explicitly built for the Aave dApp. Anyone holding AAVE tokens enjoys governance rights on Aave's decentralized governance portal, allowing them to vote on proposed upgrades to the protocol or changes such as collateral requirements and interest rate adjustments. 

Aave also has a "Safety Module" where traders lock (or "stake") their AAVE tokens to earn passive rewards. In a crisis scenario, Aave can use 30% of the Safety Module's funds to prevent a shortfall, meaning stakers are always at risk of losing their initial deposit. To find the price per AAVE coin, traders search for the AAVE price on crypto exchanges and price aggregator websites. Because Aave is a prominent DeFi project, it's relatively easy to find AAVE price charts on many reputable crypto portals. 

What are Aave flash loans?

Flash loans are a unique service offered on Aave that allows traders to take out large sums of cryptocurrency without collateral. The catch with flash loans is traders must repay them within the same transaction block; otherwise, the smart contract will reverse the payment. Typically, traders interested in high-speed tactics like arbitrage or high-frequency trading (HFT) use Aave flash loans to take advantage of discrepancies in the digital assets market. 

How to use Aave in crypto? 

Traders who want to use Aave's services first need a self-custodial crypto wallet which works on this dApp. MetaMask is a popular option for traders using Aave on Ethereum or an Ethereum Virtual Machine (EVM) blockchain, but many other decentralized wallets also work. After opening the Aave dApp on app.aave.com, link the crypto wallet using the "Connect Wallet" icon and choose one of Aave's available services. 

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