What is Aave?

Aave is the world's largest decentralised lending protocol, allowing users to borrow, lend, and earn yield without banks. Here's how the DeFi giant works.

What is Aave crypto?

Aave is a DeFi lending platform that allows users to lend and borrow cryptocurrencies without relying on traditional financial institutions.

Rather than matching individual lenders with borrowers, Aave pools users' assets into shared liquidity pools. Anyone can deposit supported cryptocurrencies into these pools to earn interest, while borrowers can access those funds by providing sufficient collateral.

Founded in 2017, Aave has grown into one of the largest DeFi protocols by total value locked (TVL), supporting dozens of cryptocurrencies across multiple blockchain networks including Ethereum, Polygon, Arbitrum, Optimism and Avalanche.

Unlike a traditional bank, Aave operates entirely through smart contracts. Interest rates adjust automatically depending on supply and demand, while loans, repayments and liquidations are executed on-chain without human intervention.

Over several iterations, including Aave V1, V2, and the current V3, the protocol has expanded to include cross-chain functionality, capital efficiency improvements, and advanced risk management tools, making it one of the cornerstones of the DeFi market.

Who created Aave?

Aave was founded by Stani Kulechov, a Finnish entrepreneur and lawyer who recognised the potential of blockchain technology to modernise financial services.

The project originally launched under the name ETHLend in 2017 during the ICO boom. ETHLend attempted to connect lenders directly with borrowers through peer-to-peer lending. While innovative, the model struggled to attract sufficient liquidity.

In 2018, Kulechov and his team rebranded the project as Aave, meaning "ghost" in Finnish, and shifted towards a pooled liquidity model. That decision proved transformative, allowing the protocol to scale significantly while simplifying the borrowing process.

Now Aave is governed by its community through the AAVE governance token, although Kulechov remains one of the protocol's most recognisable figures.

How does Aave work?

Aave works by bringing together two groups of users: lenders who want to earn passive income and borrowers who need access to crypto liquidity.

When users deposit assets into Aave, those funds are added to liquidity pools. Borrowers can then access these pools by depositing collateral worth more than the amount they wish to borrow.

For example, someone holding ETH who doesn't want to sell it may deposit that ETH as collateral before borrowing USDC. This allows them to unlock liquidity while maintaining exposure to any future rise in Ethereum's price.

Interest paid by borrowers is distributed among lenders, with rates adjusting automatically according to utilisation. If demand to borrow an asset increases, interest rates rise to encourage more deposits. When borrowing demand falls, yields typically decrease.

Everything is managed by smart contracts, meaning there is no bank deciding who qualifies for a loan or manually processing repayments.

How can I trade on Aave?

Although Aave isn't a trading platform like a decentralised exchange, it provides several financial services that investors use to generate yield, access liquidity and optimise their crypto portfolios.

Lending

Lending is the simplest way to use Aave.

Users deposit supported cryptocurrencies into liquidity pools and immediately begin earning interest. Depositors receive aTokens, such as aUSDC or aETH, which represent their deposited assets and automatically increase in value as interest accrues.

Unlike traditional savings accounts, deposits remain available for withdrawal at any time, provided sufficient liquidity exists within the pool.

Returns vary according to borrowing demand, making yields dynamic rather than fixed.

Borrowing

Borrowing allows users to access liquidity without selling their crypto holdings.

To borrow, users must first deposit collateral. Each asset has a maximum loan-to-value (LTV) ratio, which determines how much can be borrowed against it.

For example, if ETH has an LTV of 80%, depositing $10,000 worth of ETH could allow borrowing up to $8,000 of another supported asset.

Collateralisation is central to Aave's risk model. Loans are overcollateralised, meaning borrowers always lock in more value than they borrow. This protects lenders if market prices move sharply.

Borrowers must also monitor their Health Factor, a metric that measures how close a position is to liquidation. As collateral values fall or borrowed assets appreciate, the Health Factor declines.

If it falls below 1.0, liquidators can repay part of the outstanding debt in exchange for a portion of the borrower's collateral at a discount. This automated liquidation process helps keep the protocol solvent.

Repayments can be made at any time, allowing users to recover their collateral once outstanding debt and accrued interest have been settled.

Flash loans

Flash loans are one of Aave's most innovative features.

Unlike traditional loans, flash loans require no collateral because they must be borrowed and repaid within the same blockchain transaction.

If repayment does not occur before the transaction ends, the entire transaction is automatically reversed as though it never happened.

Flash loans are primarily used by developers, arbitrage traders, and advanced DeFi users for strategies such as:

• Arbitrage between exchanges

• Collateral swaps

• Debt refinancing

• Liquidation opportunities

Although powerful, flash loans require technical knowledge and are generally unsuitable for beginners.

Staking

AAVE token holders can stake their tokens within the protocol's Safety Module.

Rather than securing the blockchain like proof-of-stake networks, staking on Aave helps protect the protocol against potential shortfalls resulting from unexpected losses.

In exchange for helping backstop the protocol, stakers receive rewards funded through protocol incentives.

However, staking carries a unique risk known as slashing, where a percentage of staked tokens could be used to recapitalise the protocol during extreme events.

Savings

For many users, Aave effectively functions as a decentralised savings account.

Stablecoins such as USDC, USDT, and DAI can be deposited to generate passive yield while remaining relatively insulated from crypto price volatility.

Because interest rates fluctuate according to supply and demand, returns are variable rather than guaranteed. During periods of high borrowing activity, stablecoin yields can increase substantially before falling as utilisation declines.

What's Aave Pro?

Aave Pro, also known as Aave Arc, was developed as a permissioned version of the protocol designed for institutional participants.

While Aave V3 is fully permissionless, allowing anyone with a compatible wallet to participate, Aave Pro requires users to complete identity verification through approved whitelisting providers before accessing liquidity pools.

This creates an environment that better aligns with institutional compliance requirements while retaining many of the benefits of decentralised finance.

Compared to Aave V3, Aave Pro offers permissioned liquidity pools, verification for institutional participants, and greater regulatory compliance.

What is the AAVE token?

AAVE is the protocol's native governance token.

Rather than serving as a payment token, AAVE gives holders voting rights over protocol upgrades, treasury management, risk parameters, and future development.

Token holders can submit governance proposals or vote on changes affecting supported assets, collateral requirements, interest rate models, and ecosystem incentives.

The token also plays an important role in the protocol's Safety Module, where it can be staked to help protect Aave against unexpected financial shortfalls.

AAVE tokenomics

According to CoinMarketCap:

• Ticker: AAVE

• Maximum supply: 16 million AAVE

• Circulating supply: Approximately 15.2 million AAVE

• All-time high (ATH): $666.86 

• All-time low (ATL): $26.02

What are the risks of using Aave?

Although Aave is considered one of the most battle-tested DeFi protocols, it still carries risks that users should understand before depositing funds.

Smart contract vulnerabilities remain a possibility despite multiple security audits. While the protocol has operated successfully for years, no software is immune to undiscovered bugs.

Market volatility presents another significant risk. Sharp price movements can quickly reduce collateral values, triggering liquidations if borrowers fail to maintain a healthy collateral ratio.

Liquidity constraints may also arise during periods of extreme market stress, temporarily limiting withdrawals from heavily utilised pools.

Finally, regulatory uncertainty continues to affect the wider DeFi market. Future legislation governing decentralised lending could impact how protocols such as Aave operate in certain jurisdictions.

Pros and cons of Aave

Has Aave ever been exploited?

Unlike many DeFi protocols, Aave's core lending contracts have never suffered a catastrophic exploit resulting in the loss of user deposits.

However, the protocol has been involved in several security incidents and governance responses. In 2022, Aave paused lending markets for several assets after identifying unusual borrowing behaviour that could have exposed the protocol to manipulation. The issue was resolved through governance without any loss of user funds.

Flash loans have also been used by attackers to exploit vulnerabilities in third-party DeFi protocols. Because Aave pioneered flash loans, these attacks are sometimes incorrectly associated with Aave itself. In reality, the protocol simply provided the temporary liquidity, while the vulnerabilities existed elsewhere.

Like all major DeFi platforms, Aave continues to undergo regular security audits, bug bounty programmes and governance-led risk assessments to strengthen protocol resilience as new features are introduced.

Don’t forget the tax bill…

If you’re using Aave to lend or borrow, you have a tax bill. You can learn more in our guide on DeFi taxes, or sign up to Koinly for free to automatically track and calculate your Aave tax liability.