For those who have been keeping an eye on the DeFi Pulse leaderboard, you’ve surely seen the spooky project Aave creeping into the #4 spot – recently passing Uniswap in the past 48 hours.


While we’ve covered Aave extensively here on DeFi Rate in the past, we’ll be using this article to shed some light on what makes the sector rising lending protocol unique to money market protocols like Compound. We’ve seen quite a lot of attention on crypto Twitter as of late are hoping to show why this is the case.

 

TLDR: Aave recently showcased a sneak peek at their new collateral system in which users can post Uniswap liquidity tokens and TokenSets as collateral all while having those assets insured using the protocol’s native token – LEND and a backstop of stablecoins like Dai and USDC.

An Overview on Aave

For those looking for a quick refresher, Aave currently offers the most diverse asset to lend and borrow – including popular DeFi tokens like MKR, KNC, SNX and LINK. We recently covered their new Risk Framework which dives into how new assets are added to the protocol and the relevant risk grades associated with them.

The protocol was first popularized through its capacity to offer Flash Loans, or the ability for anyone to take out a borrow of any size so long as it is paid back in the first block. This lead to the creation of tools like DeFi Saver which use Aave’s flash loans to provide automated asset management on Maker Vaults.

In addition to Flash Loans, Aave allows borrowers to take out a Stable Loan, meaning the APR is fixed over a predefined amount of time. This comes in tandem with their integration into Swap Rate which allows users to trade with up to 10x leverage on lending and borrowing rates.

Underpinning all of this is the LEND token, which up until now has largely been used as collateral for borrowing other assets. In the last few weeks, we saw this tool for tracking LEND burns, which is primarily fueled by Aave using ~85% of protocol fees to buy and burn LEND off the open market.

What’s New?

Flash forward to today and Aave is gearing up for the release of their new governance paper, akin to Kyber and their Katalyst token upgrade. While a lot of these new features have only been teased, this weekend’s virtual summit was a breeding ground for users to learn more about what’s to come.

Right off the bat, we can expect LEND to be staked for both governance rights and as an insurance buffer on borrowed positions. Similar to how MKR works on Maker, those staking LEND will be committing to act as the first line of defense in the event the system suffers a mass liquidation event like what we saw with wBTC being drained from bZx a while back. In the rare event that this does not provide enough coverage, users will be able to pool stablecoins as the line of last defense.

Now you may be wondering – Why would I supply collateral that could be liquidated in crisis?

Simply put – protocol fees. Those who stake LEND will be eligible to earn a pro-rata claim on trading fees (currently 0.25%) which are determined by stakeholders. Rather than trading fees being used to burn LEND as it’s used today, they will be redistributed backstoppers while stakers earn inflation (similar to SNX) for governing how the entire system operates.

If you’re not sold on the promise of fees that have been collected so far, here’s where things get interesting.

Interest-Earning Collateral

As it stands today, those providing liquidity on Uniswap are sacrificing the opportunity costs of lending those assets out on money markets. While we’ve seen rare examples like the Synthetix and their sETH Unipool incentives, the vast majority of Uniswap pools require users to stay in one position for a long time to capture DEX trading fees.

With this new framework, Aave is now allowing users to post those LP tokens as collateral, meaning you can borrow against an asset which is collecting trading fees. Building on this notion of composability, users will also be able to lend and borrow against TokenSets, giving them a tried and true way to keep their underlying assets in an automated assets management strategy while leveraging the benefits of enhanced DeFi exposure.

When asked for comment on these upcoming changes, Jordan Lazaro Gustave – the COO of Aave commented:

“(LEND) tokenomics and governance are taking inspiration from the best models out there. Having a native backstop ready in case of stake slashing or minting events creates a powerful cycle for security and liquidity”

The Big Picture

Boiling it all down, we can start to see how Aave is differentiating itself from other key lending protocols. By creating a cycle in which those who stake LEND govern the protocol and collect trading fees, incentives are entirely dictated by the community of users.

Taking this a step further, it’s likely that each money market (for example Aave-based Uniswap pools, TokenSets, etc.) will have unique liquidity based governance, meaning someone who supplies capital to the Uniswap arm of the protocol will have more power over how it is governed than someone who is simply staking LEND or borrowing LINK.

In summary, it’s interesting to look at Aave as a protocol for money market creation. As we continue to watch new features, assets and use-cases integrating into the sector rising project, it’s no surprise Aave has been seeing such strong growth in recent weeks.

To stay up to date with the project, follow them on Twitter or join the conversation on Discord.

Disclaimer: As the author of this article I am long on Aave and LEND. This content is not investment advice and should not be treated as such. We advise anyone reading this post to do their own diligence and proceed at their own risk. DeFi Rate intends to act as a protocol politician for Aave in the future.