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ITSA DeFi Insight — Aave Lending Markets

Aave is a decentralized lending platform that eliminates intermediaries and lets users lend, borrow, and earn interest on crypto assets. This implies that Aave users do not have to put their trust in a certain company or individual to manage their money. They merely need to believe that the code will run exactly as intended. Aave requires borrowers to provide collateral before they may borrow, similar to other decentralized lending platforms on Ethereum. Additionally, the amount they can borrow is limited to the value of the posted collateral. An aToken, a unique token that is tied to the value of another asset, is given to borrowers as payment. Aave can also add further features like fast loans and other ways of extending credit and creating debt that make use of the special characteristics of blockchain technology.

Authors: Christian Viehof, Valentin Kalinov

How does Aave work?

The best way to characterize Aave is as a platform of lending pools. Participants deposit the tokens they want to lend in the respective pools, and when taking out a loan, borrowers may then draw from those pools. Aave provides two different kinds of tokens: aTokens, which are given to lenders so they can get interest on deposits, and the Aave token, which is Aave’s own native token. Holders of the Aave token can benefit from a number of things. For instance, if Aave borrowers take out loans with Aave as collateral, there is no fee. If they pay a fee in Aave, Aave owners can view loans in greater detail before they are made available to the general public. Aave collateralized borrowers are also permitted to borrow a little bit more.

Aave enables some loans, referred to as flash loans, to be made and cleared instantaneously. These loans are nearly instantaneous and don’t demand any upfront collateral. Flash loans take advantage of a characteristic shared by all blockchains: transactions only become final after the network accepts a fresh collection of transactions known as a block. Each new block addition takes time. That time frame on Bitcoin is approximately ten minutes. On Ethereum, it’s 13 seconds. Therefore, in that 13-second span, an Aave flash loan comes into play. The flash loan operates as follows: Aave allows users to borrow money, but they are required to repay it along with a 0.09 percent fee in one block. If the borrower fails to comply, the entire transaction is voided, making it appear as if no money was ever borrowed. As a result, neither the borrower nor Aave takes a risk. A borrower might want to deploy a flash loan to profit from trade opportunities or boost earnings from other Ethereum-based systems. To make trading profits, it is possible to swap several cryptocurrencies via flash loans automatically.

 

Aave Dashboard overview of stats
Figure 1: Aave platform overview (source: https://app.aave.com/)

 

Aave V3 — new features

Through the Portal feature, liquidity can now move between Aave V3 marketplaces on other networks. With the improved V3, governance-approved bridges can quickly mint aTokens on the destination network while burning them on the source network. After flowing across a bridge and into the pool, the underlying assets can then be delivered to Aave on the destination network in a deferred manner. With the advent of the portal feature, assets can now move across Aave iterations using various blockchains.

Although a vital component, bridges have inherent hazards that have already resulted in the theft of hundreds of millions of dollars this year. The Wormhole and Ronin exploits are two of 2022’s most significant examples. Bridges are regarded as a weak point in the transactional chain that, for a brief while, exposes tokens to higher risks.

By introducing bridges that have received governance approval, Aave places its customers at the center of decision-making. The portal feature also needed little adjustment because it uses Aave’s interest-bearing aTokens to mint them instantly on the destination network while burning them on the source network.

 

Aave’s miltichain portal
Figure 2: Aave multichain portal (source: https://bit.ly/3RO2RLu)

When the price of the provided and borrowed assets are connected, especially when both are derivatives of the same underlying asset, the High-Efficiency Mode, or eMode, enables borrowers to get the most borrowing power out of their collateral (e.g. stablecoins pegged to USD).

With e-mode, new use cases are made possible, including diversified risk management, very efficient yield farming (for example, depositing ETH and staking derivatives to borrow ETH), and high leverage forex trading.

 

Aave’s high-efficiency mode overview
Figure 3: Aave High-Efficiency Mode (source: https://bit.ly/3RO2RLu)

Aave unveiled Isolation Mode, a feature modeled around MakerDAO’s exposure management strategy. Members of the Aave governance can vote on which assets should be labeled as isolated using this feature. When providing an isolated asset as collateral, borrowers are limited to borrowing a specific basket of stablecoins and are not allowed to add additional assets to their collateral.

 

Aave’s isolation mode overview
Figure 4: Aave Isolation Mode (source: https://bit.ly/3RO2RLu)

Risk management revamp

Aave V3 offers more complex parameters and functionality than Aave’s earlier iterations. Most notably, Aave governance voters can now modify asset borrow and supply caps to regulate the maximum amount that can be borrowed and supplied for each asset. Without affecting current borrowers, Aave governance can reduce the borrowing power control of any asset to zero percent. Aave V3 also adds the capability for Aave governance to allow entities to adjust the protocol’s risk parameters without requiring a governance vote for each change. These entities may take the form of DAOs or automated agents like Gauntlet, which may be built upon to respond automatically to unanticipated situations.

The majority of the assets from Aave that originally originated on Ethereum are migrated to Layer-2 due to the high throughput, scalability, and affordability of Layer-2 networks. A sophisticated pricing oracle sentinel was introduced by V3 to help with some of the problems in Layer-2 networks. In addition to introducing a grace period for liquidations and disabling borrowing in specific situations, the functionality is made for Layer-2 to handle any sequencer outages. To conclude a series of creative risk management improvements, the liquidation mechanism has been enhanced in V3 to enable full liquidation of a position when it nears insolvency. Before, only half of the position could ever be liquidated.

 

The classification of Aave according to the ITC

Aave is the primary token of the Aave lending protocol providing an on-chain governance functionality to its holders so that they can participate in the decision-making process on how the platform is managed.

 

The classification of the Aave token according to the ITC
Figure 5: The Aave Tokenbase entry (Source: https://itin.itsa.global/XH23WHP23)

Economic Purpose (EEP): Aave is listed as a Settlement and Governance Token (EEP22TU03) due to its design as a means of collateral combined with governance functionality.

Industry Type (EIN): The issuer of Aave is active in the field of Decentralized Lending, Saving and Asset Management (EIN06DF02).

Technological Setup (TTS): Aave is an Ethereum ERC-20 Standard Token (TTS41BC). The Class “Ethereum ERC-20 Standard Token” captures every Token that is implemented by means of the ERC-20 Standard on top of the Ethereum blockchain.

Legal Clam (LLC): Aave does not entitle its holder to any legal claim or rights against the issuing organization; therefore, it is listed as a No-Claim Token (LLC31).

Issuer Type (LIT): The dimension “Issuer Type” provides information on the nature of the issuer of the token. Aave’s platform is built by a team of programmers and engineers that make up the core contributor community and is organized via a DAO. Its Issuer Type is an Application Layer Protocol (LIT62AL).

Regulatory Framework (EU) (REU): The dimension “Regulatory Status EU” provides information of the potential classification of a token according to the European Commission’s proposal for a Regulation on Markets in Crypto Assets (MiCA, Regulation Proposal COM/2020/593 final). Aave qualifies as a Utility Token (REU52) according to the definition provided in Article 3 (5) of Regulation Proposal COM/2020/593 final.

 

List of all Aave V2 tokens listed in the ITSA Tokenbase
Figure 6: Aave V2 aToken list (source: https://api.itsa.global/view-list?list_id=25)

The International Token Standardization Association (ITSA) e.V.

The International Token Standardization Association (ITSA) e.V. is a not-for-profit association of German law that aims at promoting the development and implementation of comprehensive market standards for the identification, classification, and analysis of DLT- and blockchain-based cryptographic tokens. As an independent industry membership body, ITSA unites over 100 international associated founding members from various interest groups. In order to increase transparency and safety on global token markets, ITSA currently develops and implements the International Token Identification Number (ITIN) as a market standard for the identification of cryptographic tokens, the International Token Classification (ITC) as a standard framework for the classification of cryptographic tokens according to their inherent characteristics. ITSA then adds the identified and classified token to the world’s largest register for tokens in our Tokenbase.

  • The International Token Identification Number (ITIN) is a 9-digit alphanumeric technical identifier for both fungible and non-fungible DLT-based tokens. Thanks to its underlying Uniform Token Locator (UTL), ITIN presents a unique and fork-resilient identification of tokens. The ITIN also allows for the connecting and matching of other media and data to the token, such as legal contracts or price data, and increases safety and operational transparency when handling these tokens.
  • The International Token Classification (ITC) is a multi-dimensional, expandable framework for the classification of tokens. Current dimensions include technological, economic, legal, and regulatory dimensions with multiple sub-dimensions. By mid-2021, there will be at least two new dimensions added, including a tax dimension. So far, our classification framework has been applied to 99% of the token market according to market capitalization of classified tokens.
  • ITSA’s Tokenbase currently holds data on over 4000 tokens. Tokenbase is a holistic database for the analysis of tokens and combines our identification and classification data with market and blockchain data from external providers. Third-party data of several partners is already integrated, and API access is also in development.

Remarks

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Christian Viehof is an Executive Director at the International Token Standardization Association (ITSA) e.V., working to create the world’s largest token database including a classification framework and unique token identifiers and locators. He completed his Bachelor in Economics at the University of Bonn, the Hong Kong University and the London School of Economics and Political Science with a focus on Behavioral Economics and Finance. Currently pursuing his Master of Finance at the Frankfurt School of Finance and Management, you can contact him via christian.viehof@itsa.global and connect with him on Linkedin, if you would like to further discuss ITSA e.V. or have any open questions.

Valentin Kalinov is an Executive Director at International Token Standardization Association (ITSA) e.V., working to create the world’s largest token database, including a classification framework and unique token identifiers and locators. He has over five years of experience working at BlockchainHub Berlin in content creation and token analysis, as a project manager at the Research Institute for Cryptoeconomics at the Vienna University of Economics and token analyst at Token Kitchen. You can contact Valentin via valentin.kalinov@itsa.global and connect on LinkedIn if you would like to further discuss ITSA e.V. or have any other open questions.