Introduction to Aave
Aave is an open-source, non-custodial liquidity protocol for earning interest on deposits and borrowing assets. It’s one of the leading decentralized finance (DeFi) lending platforms, allowing users to participate as depositors or borrowers in a completely trustless manner. Aave pioneered innovative features like flash loans and rate switching, and operates across multiple blockchain networks including Ethereum, Polygon, Avalanche, and others.
Core Concepts & Principles
Key Terminology
| Term | Definition |
|---|---|
| Liquidity Pool | Smart contract containing funds supplied by depositors |
| Supply/Deposit | Adding assets to Aave’s liquidity pools to earn interest |
| Borrow | Taking a loan from Aave’s liquidity pools using collateral |
| Collateral | Assets deposited that secure borrowed positions |
| Health Factor | Key risk metric determining liquidation risk (target >1.0) |
| Liquidation | Process of selling collateral when health factor falls below 1.0 |
| LTV (Loan-to-Value) | Maximum amount you can borrow with a specific collateral |
| Liquidation Threshold | Collateral value level that triggers liquidation |
| Liquidation Penalty | Fee charged during liquidation (varies by asset) |
| Flash Loan | Uncollateralized loan that must be repaid in the same transaction |
Interest Rate Models
| Rate Type | Description | Best For |
|---|---|---|
| Variable Rate | Fluctuates based on protocol utilization | Long-term positions in stable market conditions |
| Stable Rate | Fixed for a period but can be rebalanced | Short to medium-term positions requiring predictability |
| Fixed Rate | Unchanging rate for the loan duration (via Aave v3 GHO) | Budget-sensitive borrowers needing certainty |
Aave Tokens
| Token | Purpose | Function |
|---|---|---|
| AAVE | Governance token | • Voting on protocol changes<br>• Staking<br>• Fee reductions |
| aTokens | Interest-bearing tokens | • Automatically accrue interest<br>• 1:1 backed by underlying asset<br>• e.g., aUSDC, aETH |
| Debt Tokens | Represent borrowed amounts | • Variable debt tokens (e.g., variableDebtUSDC)<br>• Stable debt tokens (e.g., stableDebtUSDC) |
| GHO | Aave’s native stablecoin | • Overcollateralized stablecoin<br>• Partially backed by Aave treasury |
| stkAAVE | Staked AAVE token | • Earn protocol fees<br>• Safety Module protection<br>• Cooldown period for unstaking |
Aave Protocol Versions
Version Comparison
| Feature | Aave v1 | Aave v2 | Aave v3 |
|---|---|---|---|
| Launch Date | January 2020 | December 2020 | March 2022 |
| Key Features | • Flash loans<br>• Multiple assets<br>• Rate switching | • Credit delegation<br>• Collateral swapping<br>• Improved gas efficiency | • Portal (cross-chain)<br>• Isolation mode<br>• Efficiency mode<br>• Siloed borrowing |
| Networks | Ethereum | • Ethereum<br>• Polygon<br>• Avalanche | • Ethereum<br>• Polygon<br>• Avalanche<br>• Arbitrum<br>• Optimism<br>• Fantom<br>• Harmony |
| Current Status | Deprecated | Active | Active (primary version) |
Aave v3 Key Innovations
| Feature | Description | Benefits |
|---|---|---|
| Isolation Mode | Limits borrowing for new/risky collaterals | Reduced risk when onboarding new assets |
| Efficiency Mode (E-Mode) | Higher LTV for correlated assets | More capital efficiency for similar assets (e.g., stablecoins) |
| Portal | Cross-chain functionality | Allows bridging debt positions across networks |
| Supply/Borrow Caps | Limits on total supply/borrowing | Risk mitigation against market manipulation |
| Siloed Borrowing | Restricts assets to single-asset borrowing | Mitigates contagion risk from volatile assets |
| GHO Stablecoin | Native Aave USD-pegged stablecoin | Provides stable borrowing option backed by Aave |
Using Aave: Step-by-Step Processes
Supplying Assets
- Connect Wallet: Link your crypto wallet (MetaMask, WalletConnect, etc.)
- Navigate to Supply: Go to the “Supply” section of Aave interface
- Select Asset: Choose which token to supply
- Enter Amount: Specify how much to deposit
- Approve Contract: Authorize Aave smart contract to use your tokens
- Confirm Transaction: Approve the transaction in your wallet
- Receive aTokens: Automatically receive interest-bearing aTokens
Borrowing Assets
- Supply Collateral: Deposit assets to use as collateral
- Enable Collateral: Toggle on the “Use as Collateral” switch
- Navigate to Borrow: Go to the “Borrow” section
- Select Asset: Choose which token to borrow
- Select Rate Type: Choose variable or stable interest rate
- Enter Amount: Specify how much to borrow (watch your health factor!)
- Confirm Transaction: Approve the transaction in your wallet
- Monitor Health Factor: Keep track of your position’s safety
Repaying Loans
- Navigate to Borrow: Go to your borrowed positions
- Select Asset: Choose which loan to repay
- Enter Amount: Specify how much to repay (partial or full)
- Approve Token: If not previously approved, authorize token spending
- Confirm Transaction: Approve the transaction in your wallet
- Verify Repayment: Check that your debt has decreased
Using Flash Loans
- Create Smart Contract: Develop contract implementing
flashLoan()function - Define Loan Logic: Program what happens during the flash loan
- Include Repayment: Ensure loan repayment (plus fee) before end of transaction
- Deploy Contract: Deploy your contract to the blockchain
- Execute Function: Call the function that triggers the flash loan
- Monitor Execution: Verify transaction completed successfully
Risk Management
Key Risk Metrics
| Metric | Description | Target Value |
|---|---|---|
| Health Factor | Overall safety of your position | >1.5 (safe zone)<br>1.0-1.5 (caution zone)<br><1.0 (liquidation zone) |
| Liquidation Threshold | When liquidation can occur | Asset-specific (e.g., ETH: 82.5%) |
| Maximum LTV | Maximum borrowing power | Asset-specific (e.g., ETH: 80%) |
| Liquidation Penalty | Extra fee during liquidation | Asset-specific (e.g., ETH: 5%) |
| Utilization Rate | % of pool funds being borrowed | Impacts interest rates |
Avoiding Liquidation
- Maintain High Health Factor: Keep above 1.5 for safety margin
- Monitor Market Conditions: Watch for high volatility periods
- Diversify Collateral: Use multiple assets to spread risk
- Set Up Alerts: Configure notifications for health factor drops
- Add More Collateral: Deposit additional assets if health factor decreases
- Partially Repay Loans: Reduce debt to improve health factor
- Use Stablecoins: Consider stablecoins for less volatile positions
- E-Mode Efficiency: Use E-Mode for correlated assets (e.g., all stablecoins)
Liquidation Process
- Health Factor Drops: When health factor falls below 1.0
- Liquidator Action: External actors (liquidators) repay part of the loan
- Collateral Seizure: Liquidator receives collateral plus liquidation bonus
- Partial Liquidation: Up to 50% of debt can be liquidated at once
- Remaining Position: User keeps remaining collateral with improved health factor
Advanced Strategies
Yield Optimization
| Strategy | Description | Risk Level |
|---|---|---|
| Supply Stablecoins | Deposit stablecoins for consistent yield | Low |
| Leveraged Positions | Borrow against supplied assets to supply more | Medium-High |
| Stable vs. Variable Rate Arbitrage | Switch between rate types based on market conditions | Medium |
| GHO Minting | Borrow GHO against collateral for stable-rate loans | Medium |
| Flash Loan Arbitrage | Use flash loans to exploit price differences across platforms | High |
| Recursive Borrowing | Supply → Borrow → Supply same asset for leverage | High |
Yield Farming with Aave
- Supply Liquidity: Deposit assets to Aave
- Borrow Assets: Take out loans against your collateral
- Farm with Borrowed Assets: Use borrowed funds in other DeFi protocols
- Compare APY: Ensure farming returns exceed borrowing costs
- Manage Risk: Monitor health factor and market conditions
- Take Profits: Regularly harvest and compound rewards
- Exit Strategy: Plan for quick position unwinding if needed
Credit Delegation
- Delegator Supplies Assets: Deposit collateral to Aave
- Set Up Delegation: Specify borrower address and loan terms
- Establish Agreement: Create legal or smart contract agreement off-chain
- Borrower Takes Loan: Approved address borrows without own collateral
- Repayment Responsibility: Borrower repays according to agreement
- Default Management: Delegator’s collateral at risk if borrower defaults
Common Challenges & Solutions
| Challenge | Solution |
|---|---|
| Volatile Collateral Value | • Use stablecoins as collateral<br>• Maintain higher health factor<br>• Set up alerts for price movements |
| High Gas Fees (Ethereum) | • Use layer 2 solutions (Polygon, Arbitrum, Optimism)<br>• Batch transactions<br>• Time transactions during low network congestion |
| Interest Rate Fluctuations | • Use stable rate for predictability<br>• Monitor utilization rates<br>• Consider GHO for stable borrowing |
| Limited Borrowing Power | • Use E-Mode for higher LTV<br>• Diversify collateral types<br>• Supply assets with higher LTV ratios |
| Impermanent Loss Risk | • Balance LP tokens and direct supply<br>• Choose correlated pairs for LP tokens<br>• Monitor pool performance |
| Smart Contract Risk | • Verify protocol audits<br>• Use insurance protocols<br>• Diversify across platforms |
Technical Aspects
Key Smart Contracts
| Contract | Function | Interaction |
|---|---|---|
| LendingPool | Core lending functionality | Supply, borrow, repay, liquidate |
| AaveProtocolDataProvider | Provides market data | Get user account data, reserve data |
| PriceOracle | Asset price information | Used for collateral valuation |
| AaveOracle | Chainlink integration | Secure price feeds |
| IncentivesController | Manages rewards | Distributes AAVE rewards |
| AaveGovernance | Protocol governance | Voting, proposal execution |
Important ABIs and Methods
- supply(): Deposit assets into the protocol
- borrow(): Borrow assets from the protocol
- repay(): Repay borrowed assets
- withdraw(): Withdraw supplied assets
- setUserUseReserveAsCollateral(): Enable/disable collateral
- swapBorrowRateMode(): Switch between stable and variable rates
- flashLoan(): Execute a flash loan
- getUserAccountData(): Get user’s health factor and positions
Networks and Deployments
| Network | RPC URL | Chain ID | Explorer |
|---|---|---|---|
| Ethereum Mainnet | https://mainnet.infura.io/v3/ | 1 | Etherscan |
| Polygon | https://polygon-rpc.com | 137 | PolygonScan |
| Avalanche | https://api.avax.network/ext/bc/C/rpc | 43114 | SnowTrace |
| Arbitrum | https://arb1.arbitrum.io/rpc | 42161 | Arbiscan |
| Optimism | https://mainnet.optimism.io | 10 | Optimistic Etherscan |
Governance & Tokenomics
AAVE Token Utility
- Voting Rights: Participate in Aave Improvement Proposals (AIPs)
- Staking: Deposit AAVE to the Safety Module to earn rewards
- Fee Discounts: Reduced fees for protocol activities
- Governance Delegation: Delegate voting power to others
- Treasury Management: Decide on protocol treasury allocations
Governance Process
- Discussion: Community forum debate on potential changes
- ARC (Aave Request for Comments): Formal proposal discussion
- AIP (Aave Improvement Proposal): Official on-chain proposal
- Voting: AAVE token holders vote on proposal
- Timelock: Successful proposals enter timelock period
- Implementation: Changes executed after timelock expires
Safety Module
- Purpose: Insurance fund against shortfall events
- Staking: Users stake AAVE or aToken/ETH LP tokens
- Rewards: Earn additional AAVE tokens as incentives
- Slashing Risk: Up to 30% of stake can be slashed in shortfall event
- Cooldown Period: 10-day waiting period before unstaking
- Unstake Window: 2-day window to withdraw after cooldown
Best Practices & Tips
For Depositors
- Compare Rates: Check rates across different platforms
- Consider Impermanent Loss: Be cautious with volatile assets
- Compound Interest: Allow aTokens to accrue for maximum returns
- Monitor Protocol Usage: High utilization can signal higher risk
- Participate in Governance: Vote on proposals affecting your assets
- Tax Tracking: Keep records of deposits, withdrawals, and interest
For Borrowers
- Conservative LTV: Borrow less than maximum allowed
- Rate Selection: Choose stable rates during low utilization, variable during high
- Liquidation Avoidance: Set up alerts and maintain buffer
- Purposeful Borrowing: Have clear strategy for borrowed assets
- Regular Monitoring: Check health factor at least weekly
- E-Mode Utilization: Use for higher efficiency with correlated assets
- GHO Consideration: Evaluate GHO for stable-rate borrowing
For Developers
- Testing: Use testnet deployments before mainnet
- Simulation: Simulate edge cases for flash loans
- Gas Optimization: Optimize transactions for cost efficiency
- Security Audits: Audit code interacting with Aave
- Rate Monitoring: Build alerts for significant rate changes
- Fallback Mechanisms: Implement safety measures for failures
- Composability: Design for interaction with other protocols
Recent Developments & Future Outlook
Recent Protocol Updates
- GHO Stablecoin: Aave’s native overcollateralized stablecoin
- V3 Advancements: Efficiency mode, isolation mode, and portals
- Multi-chain Expansion: Deployment across numerous networks
- Risk Parameter Adjustments: Ongoing optimization via governance
- Real World Asset Integration: Exploring traditional finance assets
- Cross-chain Capabilities: Improved bridging between networks
Future Roadmap
- Institutional Integration: Compliance features for institutions
- Layer 2 Focus: Enhanced focus on scaling solutions
- Expanded Asset Types: More diverse collateral options
- Improved Oracles: Enhanced price feed mechanisms
- Additional Stablecoin Features: GHO ecosystem development
- Mobile-first Experience: Improved user interfaces
- Lending Market Innovations: New lending products and features
Resources for Further Learning
Official Resources
Analytics & Tools
Educational Content
- Aave Risk Framework Documentation
- DeFi Developer Roadmap
- Aave Protocol Whitepaper
- Flash Loan Documentation & Examples
- Community Developer Guides
Disclaimer: This cheat sheet is provided for informational purposes only and does not constitute financial advice. Crypto lending involves significant risks including but not limited to smart contract risk, liquidation risk, and market volatility. Always conduct your own research before using DeFi protocols.