Assuming that one knows nothing about the Aave protocol, we'll start with fundamental fact number one - which is that it is a cryptocurrency project with a floating exchange rate (during writing).
Old Fashioned Mode: Main Website
The main website for Aave is (you guessed it) - https://aave.com
Directly on the front of the site, there is a solid synopsis of how 'Aave' works for us to get the "general gist".
"Aave is an open source and non-custodial protocol enabling the creation of money markets. Users can earn interest on deposits and borrow assets."
Well...that sounds like these DeFi projects, but since this project is currently valued at nearly $1 billion at the time of writing ($944,306.632 to be exact), I will assume that there's a bit more to it than the relaxed definition on their site's front page conveys.
Biggest Pull For Aave Use: Interest Rates
As we just found out with yearn.finance, their big 'pull' or "value added" in the DeFi ecosystem is rooted in their role as an AMM ("automated market maker").
In that same way - Aave has their major role / 'value added' proposition / niche that they fulfill in the DeFi ecosystem too.
And that's the facilitation of "variable and stable interest rates" for users of the protocol.
How Aave Works - Punch by Punch
To expedite this review process (since there are several other constituent elements of yearn.finance that we need to get to) a great source to start with (as a purely informative frame of reference to get us quickly up to speed), is "Ivan on Tech"'s breakdown of the protocol, which can be found here = https://academy.ivanontech.com/blog/defi-deep-dive-what-is-aave
Disclaimer: Please don't be crazy enough to think that I know this guy or anything about him. I have heard of him and that's it. It seems that he gets a lot of respect in the blockchain space - which has always made me wary (and thus, is likely the reason why I have never seriously checked his content out before - because telling the pure, unadulterated truth in the blockchain space definitely doesn't win you anyf riends') - I have no valid reason to not like this dude, discredit him, etc. Never met him, seen him or appraised his work, etfforts, opinons, actions in any other content. Don't know smack abut the guy - but I can vouch for this mini article and say that its accurate in its description of the raw ideals underneath Aave.
Super ELI5 Breakdown For How Aave Works:
- "To transact on Aave, lenders must deposit funds into liquidity pools, and users can then borrow from these pools."
- "Each pool sets assets aside as reserves to hedge against volatility" (Huh? That's interesting...I thought that's what collateral was for and the burden of that is almost always placed squarely on the shoulders of the 'borrower').
- Expanding further from #2, the article by IvanOnTech states, "These reserves also help ensure that lenders can withdraw their funds when they're ready to exit the protocol" (again, I understand the underlying purpose here...but why impose that burden on the lenders themselves by using their liquidity as a hedge, in itself, against volatility? At the end of the day, this amounts to those providing liquidity being burdened with having to not only provide said liquidity but also protect / hedge against a situation where those that they have loaned out to are no longer in positions capable of returning at least the principle back to the lender in question).
Borrowing on Aave
The borrowing process is pretty similar to what we've seen on a lot of other 'DeFi Protocols' (most notably, MakerDAO + Compound).
Before we get into that though, its worth listing assets that are available on Aave to trade (could be some additional ones outside this list... or perhaps none, depending on whenever you stumble on this brief research report).
Assets Available For Borrowing / Lending on Aave's Protocol:
(article lists USDT twice for some reason; Freudian slip?)
LINK (listed again, not sure why)
LEND (this is the native asset of the Aave ecosystem)
Borrowing on Aave
To borrow on Aave, you need collateral to borrow against.
Okay, this is a concept that we should all be familiar and comfortable with at this time.
"What is collateral?"
Let's say you want to borrow your buddy's laptop. But your buddy thinks you're kind of a fuck up - so he believes there's an inherent risk in loaning you his laptop.
So to assuage his fears, you decide to give him your PlayStation 4 to hold in exchange.
You tell your friend,"Listen, if I fuck up somehow and end up losing / destroying your laptop, then you can have my PS4."
While the PS4 does not entirely cover the value of the laptop that you're borrowing, it does provide your friend with some sort of they can actualize if you really do screw up and lose / break their laptop.
In that scenario above, your PS4 was the collateral.
Unfortunately, one's understanding of collateral musn't stop there if they are to have a true grasp on how the Aave protocol (or most of these other DeFi protocols) really work.
Luckily, however, this concept is not that difficult either.
Essentially, one's total borrow amount must be collateralized 150% (in most standard cases).