Supplying

A user can deposit funds into the Aave Protocol as a lender, earning passive income in the form of interest payments on loans made by borrowers. The interest rate received will depend on the demand for borrowing of the asset supplied.

aToken holders enjoy ongoing earnings that fluctuate with market conditions, including:

1. Interest payments on loans - suppliers receive a portion of the interest paid by borrowers, calculated as the average borrowing rate multiplied by the utilization rate. The higher the utilization of a reserve, the higher the yield for suppliers. You can see how this works by checking the ‘borrow interest rate model’ in a spreadsheet.
2. Flash Loan fees - suppliers receive a share of the Flash Loan fees, which is equivalent to 0.09 % of the Flash Loan volume.

Risks associated with a supplying strategy:

The risks related to the Aave platform are of the smart contract variety - the risk of bugs within the protocol code and a possible hacker attack which would lead to the loss of your assets. Also, there is a liquidity risk that borrowers may not be able to repay the loans they have taken out, which could lead to a lack of funds to repay lenders.

Borrowing

A user can also use the Aave Protocol to borrow assets, using their original assets as collateral. This is a useful strategy for those who want to access funds for next investment etc. without selling their existing assets.

Risks associated with a borrowing strategy:

The risks related to the Aave platform are of the smart contract variety - the risk of bugs within the protocol code and a possible hacker attack which would lead to the loss of your assets. Next, there is a liquidation risk if the value of the collateral used to secure the loan decreases, which may lead to the loan being liquidated. In this case, the lender would sell the collateral to repay the loan, and the borrower would lose their collateral. If the borrower loses the amount borrowed, he will not be able to access his collateral.

Short position

Using borrowing, traders can "open" short positions on the platform. All they have to do is provide collateral in stablecoin for which they will be allowed to use % of the collateral to borrow another cryptocurrency for which they have a prediction of a drop in its price.

Let's take an illustrative example where you borrow 8 pieces of $ETH at the price of 1,000 $USDC for 10,000 $USDC of collateral provided. Immediately after you borrow the 8 $ETH, you can swap it on any decentralized exchange (DEX) for $USDC, for which you will receive 8,000 $USDC. If your prediction is correct and $ETH goes to a price of, say, 800 $USDC for 1 $ETH, then you buy 8 $ETH again, costing you 6,400 $USDC. Your net profit is 1,600 $USDC. You can then return the 8 $ETH tokens and withdraw your deposited collateral.

Risks associated with borrowing short strategy:

If the position does not go according to your prediction, you are at risk of liquidation if the position exceeds the allowed collateral ratio. Before this happens, you must add collateral or accept a loss and return some or all of your borrowed $ETH.

Staking

Staking consists of depositing your AAVE tokens within the protocol Safety Module (SM). However, in most scenarios, the staked $AAVE is never used, and stakers can receive the rewards for Safety Iniciatives (SI) without any impact.

Risks associated with a staking strategy:

In the event of a Shortfall Event, a portion of the locked $AAVE may be auctioned to cover the deficit. The SM is designed to prevent excessive flow of $AAVE into the open market, which would further reduce the value of $AAVE. By staking $AAVE, participants are accepting the potential for a Shortfall Event and in return receive rewards in the form of SI.

We can consider Compound (Ethereum), JustLend (Tron), and Venus (BNB Smart Chain) as similar lending / borrowing protocols. All of these protocols are maintained in the top 10 in DeFi's overall TVL. They have long been the favorite platforms of DeFi enthusiasts who don't want to sell their cryptocurrencies but want to temporarily store them as collateral, for which they take a loan with which they subsequently work and earn additional profits. They have also always been historically successful and have never been subject to any major hacking attack. Our experience with each of them has been positive and they have always met the expectations and purpose for which they were created.

There are differences between these protocols compared with Aave in elnding pool structure, interest rate model, collateral requirements, and asset selection. Aave is the only protocol among the four that offers flash loans, which are uncollateralized loans that must be repaid within a single transaction. Aave also offers a wider selection of assets for both borrowing and lending than the other protocols.

We have gone through the different strategies and also the risks that these strategies involve. We mentioned similar protocols, how they are doing, and what experience we’ve had with them. In case you are inspired by any of the mentioned strategies, always familiarize yourself with them thoroughly first and always start with a small capital. For a complete analysis and detailed functioning of the Aave protocol, please refer to Aave - Protocol.