What is Aave?

How Aave works

Aave connects two groups of people: those who want to earn interest on their crypto (depositors) and those who want to borrow crypto (borrowers). Instead of a bank sitting in the middle, a set of smart contracts manages the process automatically.

Depositing: earn interest on your crypto

When you deposit tokens into Aave -- say, 1,000 USDC -- the protocol pools your deposit with those of other depositors. Borrowers can then borrow from this pool. In exchange for making your tokens available, you earn interest. The interest rate is variable and adjusts automatically based on supply and demand: when lots of people want to borrow USDC, the rate goes up; when demand is low, the rate goes down.

You can withdraw your deposit plus earned interest at any time. There is no lock-up period and no penalty for early withdrawal (though in rare cases of extremely high utilization, withdrawals may be temporarily delayed until borrowers repay or more deposits arrive).

Borrowing: take a loan without selling your assets

Borrowing on Aave works differently from a bank loan. There is no credit score, no application, and no approval process. Instead, you put up collateral -- tokens you already own -- and borrow against them.

For example, you could deposit 2 ETH as collateral and borrow 3,000 USDC. You keep your ETH (and benefit if its price goes up), and you get USDC to use however you want. You pay interest on the borrowed amount for as long as the loan is open.

The catch: your collateral must always be worth significantly more than what you borrowed. Aave requires over-collateralization, typically 120-150% depending on the asset. If your collateral drops in value, you face liquidation.

aTokens: your deposit receipt

When you deposit into Aave, you receive aTokens in return. These are receipt tokens that represent your deposit plus accrued interest. If you deposit USDC, you get aUSDC. If you deposit ETH, you get aETH.

aTokens are standard tokens on the blockchain, which means you can transfer them, use them as collateral in other protocols, or even trade them. They are a type of receipt token -- one of the most common patterns in DeFi.

Health factor and liquidation

If you borrow on Aave, the most important number to watch is your health factor. It tells you how safe your borrow position is.

Here is what the numbers mean in practice:

• Health factor above 2: Very safe. Your collateral would need to drop by more than half before liquidation.
• Health factor 1.5: Moderate safety buffer. Common target for experienced users.
• Health factor 1.0-1.2: Danger zone. A small price drop could trigger liquidation.
• Health factor at or below 1: Liquidation can occur. Liquidators (usually bots) repay part of your debt and receive a portion of your collateral at a discount as a reward. You lose a penalty, typically 5-10% of the liquidated amount.

Liquidation is not total loss. If your position is liquidated, you lose the liquidation penalty on the portion that was liquidated, but you keep the remaining collateral and the borrowed tokens. It is painful but not catastrophic -- unless you were very close to the edge and the market moved fast, which can lead to cascading liquidations.

Flash loans: borrowing and repaying in one transaction

Flash loans are one of the most innovative concepts in DeFi, and Aave pioneered them. A flash loan lets you borrow any amount of tokens with zero collateral, as long as you repay the full amount plus a small fee within the same blockchain transaction.

How is that possible? A blockchain transaction is atomic -- it either completes entirely or reverts entirely. If your flash loan transaction tries to end without full repayment, the entire transaction is reversed as if it never happened. The protocol's funds are never at risk because the loan literally cannot exist beyond a single transaction.

Flash loans are used primarily by developers and arbitrageurs for:

• Arbitrage -- buying a token on one exchange and selling it on another for a profit, all in one transaction
• Collateral swaps -- replacing the collateral backing a loan without needing to fully repay and re-borrow
• Self-liquidation -- repaying your own loan to avoid a more expensive forced liquidation

You do not need to understand flash loans to use Aave as a depositor or borrower. They are a power-user feature, but they are worth knowing about because they represent a capability that simply does not exist in traditional finance.

Aave V3: the current version

Aave has evolved through multiple versions. The current version, Aave V3, introduced several important features:

Supported networks

Aave runs on multiple blockchains, giving you flexibility in where you deposit and borrow. Supported networks include:

• Ethereum -- the original and largest deployment, with the deepest liquidity
• Arbitrum -- lower gas fees, fast transactions
• Optimism -- another Ethereum Layer 2 with low fees
• Polygon -- very low fees, popular for smaller positions
• Avalanche -- fast finality, established DeFi ecosystem
• Base -- Coinbase's Layer 2, growing rapidly

The rates and available assets differ by network. Ethereum typically has the most assets and deepest liquidity, while Layer 2 networks offer lower transaction costs. Check the DeFi metrics guide to understand how to compare APR and APY across deployments.

GHO: Aave's own stablecoin

GHO is a stablecoin created and managed by the Aave protocol. It is pegged to the US dollar and can be minted (borrowed) by Aave depositors using their collateral. Unlike borrowing USDC from a pool of depositors, minting GHO creates new tokens directly. The interest paid on GHO borrows goes to the Aave treasury rather than to depositors.

GHO represents Aave's expansion from a lending marketplace into a stablecoin issuer -- a significant step that gives the protocol more control over its economics and reduces dependence on external stablecoin issuers.

Governance: how Aave is managed

Aave is governed by holders of the AAVE token. Token holders can propose and vote on changes to the protocol, including:

• Adding or removing supported assets
• Adjusting interest rate parameters
• Changing collateral requirements and liquidation thresholds
• Deploying to new networks
• Managing the protocol treasury

This means no single company or person controls Aave. Changes happen through on-chain voting that anyone can verify. In practice, a core team (Aave Labs) proposes most changes, but the community has the final say.

Risks of using Aave

Aave is one of the most battle-tested protocols in DeFi, with over $10 billion in total value locked and years of operation without a major exploit of its core contracts. But no protocol is risk-free. Understanding the risks helps you use it wisely.

How CleanSky shows Aave positions

CleanSky automatically detects and categorizes your Aave positions:

• Deposits appear as "Savings" -- showing the underlying token, current balance (including earned interest), and the current APY
• Borrows appear as "Loans" -- showing the borrowed token, outstanding balance, and the interest rate you are paying
• Health factor is visualized clearly so you can see at a glance how safe your borrow position is

Because CleanSky is privacy-first, your Aave positions are analyzed locally without exposing your addresses to any server. Try CleanSky to see your Aave positions with full transparency and zero data collection.

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