Decentralized finance (DeFi) protocol Aave (AAVE -2.32%) has attracted over $25 billion of cryptocurrency pledged since the borrowing and lending platform launched in Jan. 2020. What's more, Aave tokens have had a stunning run since their initial coin offering (ICO) in 2017, rising from an initial price of $1.76 (adjusted for 100-to-1 swap last year) to almost $400 as of this writing. They now represent the 30th largest cryptocurrency with a market cap of nearly $5.1 billion.
Curious investors are probably wondering how the platform and service were able to attract so much capital in such a short period. As it turns out, Aave offers a huge value proposition by bringing a practice previously available only to affluent investors to the general public. Let's look at what that means.
The beauty of asset loans
Let's say an investor, Chloe, has worked hard to save up $10,000 to invest in Ether. Two weeks after her purchase, however, she has a family emergency and needs to sell some of her newly acquired Ether to cover expenses, causing her to abandon her original financial goals. Some other alternatives would be to take out a personal line of credit, which banks can stretch out to maximize interest profit, or a payday loan, which is nearly always predatory. High net worth individuals do not encounter this problem as they can simply pledge their investments, such as stocks and gold, as collateral and receive a very low-interest loan to cover unexpected expenses.
That's no longer the case. Chloe can now pledge her ETH on platforms like Aave and take out a loan to handle her family emergency. And here's the kicker: While the ETH she posts is a capital asset, she receives a loan in the form of stablecoins like DAI (DAI -0.02%), which has a one-to-one exchange rate with the U.S. dollar. Later, she can directly transfer her DAI to a crypto-fiat exchange such as Coinbase to cash out.
Under this setup, Chloe could borrow 75% of the amount of ETH she pledges ($7,500) and pay as little as 4% interest per year until she pays back the loan with her ordinary income. It's a pretty sweet deal and not even close to what major credit card companies charge for interest.
Readers are probably wondering what the catch is. There isn't any, aside from the fact the interest rate is variable, and like all variable loans, it can rise and fall. But it is generally low because of the Aave network's smart contract functionality.
If Chloe defaults on the loan, her ETH tokens will be automatically seized by the lender. As a result, there is no "borrower default premium" that is factored into the interest rate as there is with traditional peer-to-peer (P2P) lending. There is often no recourse for the latter if, say, a U.S. borrower takes out a loan from a lender in Japan and just makes a run for it.
Not just a one-trick pony
Aave offers other benefits too. For example, investors can deposit their stablecoins in the platform to earn interest with much more attractive rates of return than traditional savings accounts.
Let's say an old-fashioned investor, Eugene, wants absolutely nothing to do with the volatility in cryptocurrencies and is content with depositing his cash into a savings account. However, he can get a much better rate on his deposit than the 0.50% per year major banks are offering him by swapping his cash for the stablecoin DAI on a one-to-one basis and then depositing it to Aave. This way, he earns the 4% interest per year (or more) mentioned earlier -- less any fees -- and his funds are fully collateralized.
Overall, Aave is a DeFi platform with huge potential, and I recommend cryptocurrency investors check out its services alongside the token.