AAVE – Aave

Aave is a decentralized, open-source lending protocol on Ethereum and other blockchains that arranges overcollateralized crypto loans through automated liquidity pools instead of a counterparty. Lenders deposit assets into these pools and receive interest-bearing aTokens. Borrowers post collateral and borrow other assets against continuously accruing interest.

Aave has run on the Ethereum mainnet since January 2020 and has expanded from there to further networks. Total value locked across all versions and networks stood at around USD 17.5 billion on 21 August 2026. However, no operating company exists in the classic sense. Instead, holders of the AAVE governance token decide on risk parameters and upgrades. For users, Aave is therefore infrastructure for crypto lending within decentralized finance, not a service provider bound by contract.

From ETHLend to the liquidity pool model

Aave was first called ETHLend. The predecessor matched loans directly between two users and raised USD 16.2 million in an ICO in 2017. Yet this peer-to-peer model needed a counterparty for every loan request. Amount, asset and term all had to match. The rename to Aave followed in September 2018, along with the switch to the liquidity pool model. Lenders pay into a shared pot from which borrowers draw, as long as liquidity is available.

The protocol calculates the interest rate automatically instead of negotiating it between two parties. Aave's interest rate strategy model works with two slopes. Below the optimal utilization of a reserve, the rate climbs gently. From that point up to full utilization, it climbs steeply. Moreover, the base rate, both slopes and the maximum rate apply per reserve, not protocol-wide. The kink makes further borrowing more expensive as soon as a reserve is heavily utilized. At the same time, it makes new deposits more attractive. As a result, the model keeps liquidity free for withdrawals.

The architecture itself emerged in four development stages, which the changelog of the protocol documentation dates.

How does liquidation work on Aave?

Each asset serving as collateral carries a liquidation threshold. That threshold is the share of its value up to which a loan counts as covered. From this, the Aave software continuously calculates the health factor. The formula divides the collateral value, multiplied by the weighted liquidation threshold, by the loan amount. The documentation works through the case. Collateral of USD 10,000 with an 80% threshold and a loan of USD 6,000 produces a health factor of 1.333. Where someone posts several assets, each threshold enters the same formula on a weighted basis. A value above 1 therefore counts as covered.

When the price of the collateral falls, the health factor drops as well. In the same example, a decline to USD 7,500 is enough, and the value reaches exactly 1.0. At that mark the position becomes liquidatable. Liquidators settle part of the debt and receive collateral from the borrower in return, marked up by a liquidation bonus. Its size depends on the risk of the posted collateral. Consequently, the bonus is the incentive for third parties to close other users' positions at all.

In addition, two thresholds limit how much debt a single liquidation clears. As long as the health factor stays above 0.95, no more than 50% of the debt comes into play. That cap also requires collateral and debt of at least USD 2,000 each. If the health factor falls to 0.95 or below, a liquidator closes the position in full. The same applies if either side drops under USD 2,000.

Flash loans without collateral in a single transaction

A flash loan is a loan without any collateral. The atomicity of a transaction makes it possible. Specifically, the borrower takes the amount, uses it and repays it with the fee in the same operation. Should any part of the repayment be missing at the end, the contract logic reverts the entire transaction. Such loans therefore suit only processes that run entirely in contract code. A default cannot hit the pool, although nobody has posted collateral.

However, the protocol charges a fee on the borrowed amount for this service. Version 3 set it at 0.05%, and governance can change that rate. The flashLoanSimple function offers no waiver. A regular Aave loan works differently. It requires overcollateralization, yet runs for any length of time and ends only with repayment or liquidation.

aTokens and the protocol's own stablecoin GHO

Anyone who deposits capital into an Aave pool receives aTokens in return. These are redeemable 1:1 for the deposited asset. A continuously rising wallet balance shows the interest earned, rather than a classic rebasing. Users trigger nothing themselves. An aToken thus differs from a wrapped token at its core. It packages no asset for a foreign chain, but instead represents an interest-bearing claim against the pool.

The protocol also issues its own stablecoin with GHO. The Aave DAO approved the mainnet launch with Proposal 268, executed on 15 July 2023. Borrowers mint the units directly in the protocol, while a so-called facilitator sets the upper limit. At launch, the Aave V3 pool on Ethereum could mint up to 100 million GHO. The same decision granted holders of staked AAVE an interest discount of 30% on GHO loans.

Who sets the rules for Aave

The ticker AAVE denotes the governance token, not the protocol itself. Operation of the protocol therefore does not depend on the price of that token. Whoever holds AAVE votes on risk parameters, new markets and changes to the contracts. The code of the governance contracts provides two paths for this. Specifically, the Short Executor covers the standard case and requires a quorum of 2%. Contract upgrades and other critical interventions run through the Long Executor. That path prescribes a 6.5% quorum and a longer voting period.

Moreover, the DAO carries the residual risk of the protocol. Where uncollectible debt remains after a liquidation, the industry speaks of bad debt. The failed CRV short by Avraham Eisenberg showed how that arises. The liquidation of his position on Aave V2 left behind 2.7 million CRV in bad debt. Since the protocol moved to Umbrella, automated slashing of staked funds covers such shortfalls. Anyone who stakes AAVE thus carries a loss risk that pure governance staking does not involve.

No supervisory authority sets these rules. MiCA expressly excludes fully decentralized services without an intermediary. Using Aave from one's own wallet consequently sits outside European crypto supervision. The ESMA Q&A 2883 clarifies that authorized crypto service providers may offer crypto lending. That business nonetheless remains unregulated under MiCA. The MiCA custody rules do not protect lent assets either.