Are you looking for a way to earn interest on your crypto savings or borrow against your assets? That’s what the Ethereum-based AAVE platform is all about.
In this article we’re going to do a brief overview of AAVE and what you can do with it. We’re also going to walk you through how to get started using it. Lastly, we’ll go over some of the behind the scenes technical details of the platform including the risks you’ll need to consider before signing up.
What is AAVE?
AAVE is an open-source DeFi platform that allows users to earn interest on deposits and borrow against them. There are no KYC checks, geographic restrictions or other limitations on who can join. Currently, the platform boasts of having over $3 billion in deposits.
One important difference with AAVE and other competitors is that this platform is non-custodial. In short, that means your deposits are always in your control. This is good because it means no single person or corporation can restrict your access to your deposits.
If the Swiss company behind AAVE were to disappear tomorrow, your funds would still be available. Non-custodial platforms do have some downsides though. If your funds are lost for any reason, AAVE can’t help you recover them. If there is a successful hack and funds are stolen, non-custodial platforms typically don’t have insurance. AAVE does offer a sort of pseudo insurance which we will get to later.
AAVE is built on Ethereum. That means it’s based on one of the most battle-proven crypto networks out there. However, the platform currently only supports a handful of ERC-20 tokens for earning interest and borrowing against.
That means popular non-Ethereum assets like Litecoin and XMR aren’t supported. AAVE supports most ERC-20 stablecoins (USDT, USDC, TUSD, DAI to name a few) as well as several other popular Ethereum-based tokens such as Basic Attention Token or BAT, 0x Coin or ZRX, and Maker or MKR. The platform even indirectly supports bitcoin via the Ethereum-based Wrapped Bitcoin or WBTC.
Making Your First Deposit With AAVE
Getting started with AAVE is pretty simple, but could be a little daunting if you are new to crypto apps. To begin, visit AAVE’s official website – AAVE.com. Next, click on Enter app which will bring you to a version select screen. Unless you have a reason to, go ahead and choose the latest version. At publishing time, the latest is version 2.
Next, you can decide whether you’d like to associate a wallet so you can deposit and withdraw through it, or you can continue without associating a specific wallet. Currently, AAVE supports browser wallets like MetaMask, hardware wallets like the Ledger, and even popular custodial wallets like Coinbase. Under normal circumstances and with a proper security setup, unlocking a wallet with AAVE won’t expose you to much direct risk.
Once you are logged in, the next step is to make your first deposit so you can either start earning interest or setup the collateral to take out a loan. On the top menu you can choose the deposit tab. This will lead you to the deposit screen which will show you what the current interest rates are in annual percentage yield, or APY.
Interest rates change all the time, but during our investigation we found that stablecoins had the highest interest rates by far. For example, USDC and TUSD were both hovering around 12%. ETH, on the other hand, was trailing behind at just under 1%. Some assets even had 0% interest rates. Comparing this to other DeFi services, 12% interest for stablecoins is very competitive.
Interest rates for borrowing were also incredibly diverse. During our investigation, we found interest rates ranging from 0.16% for UNI all the way up to 25.44% for USDC, variable APR. Just as with deposits, these rates will change all the time depending on market conditions. AAVE also allows user to choose (and switch back and forth between) variable and stable APR’s. Currently, the stable APR options were even higher, with USDC coming in at a whopping 30.44%. Not all assets had a stable APR option.
AAVE explains the difference between stable and variable rates on their official website with the following:
The stable rate, as its name indicates, will remain pretty stable and its the best option to plan how much interest you will have to pay. The variable rate will change over the time and could be the optimal rate depending on market conditions. You can switch between the stable and variable rate at any time through your dashboard.
Regardless of this being a crypto loan or a traditional loan, a 25.44% to 30.44% interest rate is quite high. In fact, it’s on par with most high-interest credit cards and short term traditional finance loans. It’s important to remember, however, that the crypto economy is currently experiencing a bull market at press time. This will definitely influence interest rates both on the borrowing and lending sides. Unfortunately, AAVE doesn’t seem to populate any data under it’s historical rates section for us to compare to previous time periods.
One final thing to remember when borrowing with AAVE is that the company behind it does collect an origination fee with each loan. Specifically, the groups advises that “a 0.00001% of the loan amount is collected on loan origination”.
The AAVE Token and Staking Rewards
Another way to earn with AAVE is by owning and staking the platform’s native asset. Owners of the AAVE asset can deposit them into what the platform calls their “safety module”. The safety module is used “as a mitigation tool in case of a shortfall event”. In simple terms, if something bad happens to the market where depositors could lose some or all of their deposits, the contents of the safety module can be used to repay depositors.
As compensation for taking on the risk, deposits made into the safety module will earn a regular return called a “safety incentive”. According to stakingrewards.com, the safety incentive rate is 4.51% at press time. At current prices that would mean $0.75 per month income, per AAVE staked.
The AAVE asset has seen sharp price increases since it’s introduction from $20 in November 2020 to the current price of over $180 in January 2021.
Advanced Features of AAVE
One thing AAVE offers that some other DeFi platforms don’t is the ability to tokenize and trade or sell your interest-earning deposit directly. This works through a process called tokenization.
According to the white paper, deposits are converted into a “corresponding amount of derivative tokens” that “map 1:1 [to] the underlying assets”. These derivative tokens are called aTokens. Depositors can choose to either redeem their interest-earning aTokens for their original asset plus interest, or they can directly sell or trade aTokens on any market that supports them.
Another feature that will interest developers is what the group calls Flash Loans. These are micro-term loans that last only the length of a single Ethereum block. They allow smart contracts to take out loans without putting up collateral as long as the loan is returned with the one block window. You can read more about Flash Loans here.
Balancing the Risks Versus the Rewards
AAVE has a lot of features to offer both those seeking loans and interest income. The platform is also wide open to anyone and has zero restrictions on who can join. However, as with all DeFi platforms and apps, participating in AAVE isn’t risk-free. The main potential risks with using AAVE is that funds could be lost due to a hack, a major black swan market event, or a technical glitch stemming from smart contracts.
So far none of these seem to have happened. What’s more, the platform does have it’s safety module program that encourages individuals to essentially insure at least some assets against loss. In the end, you’ll need to carefully weigh both the opportunities and risks yourself.
Is AAVE a solid way to earn and borrow, or is it too risky? Let us know your thoughts in the comments below.