What is the Aave protocol?
Aave is a decentralized lending protocol that lets you lend and borrow cryptocurrencies, and earn yield on deposits. The project is still relatively new, as all DeFi (decentralized finance) projects are, but as of May 2021 Aave boasts over $19 billion of total value locked-in (total crypto assets deposited into the protocol’s smart contracts.)
An advantage to using Aave over a traditional lending option is that there is no loan “application” - if you have deposited a sufficient amount of collateral, you can instantly borrow another crypto asset against your deposit amount. This is also advantageous over direct trading in that you don’t lose your position on the deposited asset the way you would if you sold it in exchange for another asset.
Aave operates on the Ethereum blockchain. Aave is decentralized and open source, and through what it calls “Aavenomics,” anyone with enough AAVE can vote on the platform’s governance and development proposals.
What is the AAVE token?
Much like many other DeFi protocols wanting distributed governance, Aave’s governance and development proposals are voted on by holders of its governance token, AAVE. Unlike tokens minted directly, AAVE is a functional iteration of its first token, LEND. Aave issued LEND via token sale in 2017, using the proceeds to fund development for the platform. In October 2020, the founding team behind the Aave protocol converted the LEND tokens into AAVE to support the governance framework is uses now.
AAVE is an ERC-20 token, meaning it runs on the Ethereum blockchain. Unlike Ethereum or Bitcoin, you can’t mine the token. Instead, you can buy it via supporting exchange, and you can also choose to stake it and earn additional incentives. Aave is secured by a Safety Module (SM), a staking mechanism for AAVE tokens to act as insurance against Shortfall Events. Stakers earn AAVE as Safety Incentives along with a percentage of protocol fees. The staking process also leverages the Balancer platform using an AAVE/ETH pairing that incentivizes market liquidity and earns BAL in return.
AAVE also conveys voting rights so that holders can vote on AIPs - Aave Improvement Proposals - to have a say in how the protocol evolves.
How does AAVE compare to Bitcoin?
AAVE differs greatly from Bitcoin in terms of its market size, risk profile, and purpose.
First, Aave (and its token, AAVE), runs on the Ethereum blockchain. Bitcoin runs on its own, entirely separate blockchain: the Bitcoin blockchain. If Aave is like a program that runs on your PC, Bitcoin is the Apple iMac.
That means that earning AAVE looks completely different from earning Bitcoin. On the Bitcoin blockchain, you can earn Bitcoin through Bitcoin mining, which involves setting up a very powerful computer to run special software that solves complicated math puzzles. Since the Ethereum blockchain processes AAVE transactions, you could mine Ethereum but not Aave.
Second, Bitcoin doesn’t… do anything. It’s just a coin, and all the blockchain can do is process transactions. Aave, however, is just one of the many ways developers can use the Ethereum blockchain to create new types of products and applications. Aave is, as mentioned, a lending protocol; other protocols include decentralized exchanges and derivatives.
Third, Bitcoin’s market cap is a lot bigger than Aave. As of May 2021, Bitcoin’s market cap of $1.2 trillion dwarfs AAVE’s $8.9 billion. Bitcoin is by far the most dominant coin on the market.
Fourth, the value of AAVE and Bitcoin are dependent on different things—although the relationship is complicated.
AAVE is dependent on the strength of the lending protocol it powers. If the Aave lending protocol breaks or is prone to a hack, then this could crash the price of AAVE. Similarly, if Aave strikes a deal with JPMorgan to offer crypto loans to all of its customers, AAVE’s price could benefit. In addition, although Aave is just a few years old and lending protocols are still a novelty, Bitcoin has been around for over a decade now and is much more battle-tested.
However, it should be noted that, although AAVE is different from Bitcoin, it is far from independent from it.
Bitcoin, the coin with a larger market (by a long shot), can influence the price of all other cryptocurrencies. If Bitcoin crashes, there’s a good chance that AAVE will feel the burn too (not directly as they operate entirely distinctly, but through overall market sentiment.) And if Ethereum, the coin that powers the blockchain that supports AAVE, crashes, then AAVE’s price could be impacted. In addition, as a lending platform that takes various crypto assets as collateral, the Aave protocol and thus potentially the AAVE token’s value would react to any dramatic fluctuation in a prominent crypto asset’s value. However, if AAVE crashes, Bitcoin may be less likely to get hurt by virtue of its size.
Before trading any crypto assets it is important to understand the risks. This overview is a starting point for you to perform your own research prior to investing in a crypto asset. First and foremost:
No Canadian securities regulatory authority has expressed an opinion about Aave, including an opinion that AAVE is not itself a security and/or derivative.
Wealthsimple has performed a legal assessment of AAVE prior to making it available on Wealthsimple Crypto and has concluded that AAVE is not and is unlikely to be deemed a security or derivative. However, there is a risk that this conclusion could change in the future and the impact of this on an asset’s value is outlined in our Product Disclosure.
We evaluated Aave based on publicly available information, including (but not limited to):
- The creation, governance, usage and design of Aave, including the source code, security and roadmap for growth in the developer community and, if applicable, the background of the developer(s) team that first created Aave;
- The supply, demand, maturity, utility and liquidity of Aave;
- Material technical risks associated with Aave, including any code defects, security breaches and other threats concerning Aave and its supporting blockchain (such as the susceptibility to hacking and impact of forking), or the practices and protocols that apply to them; and
- Legal and regulatory risks associated with Aave, including any pending, potential, or prior civil, regulatory, criminal, or enforcement action relating to the issuance, distribution, or use of AAVE.
Like all other crypto assets, there are some general risks to investing in AAVE. These include short history risk, volatility risk, liquidity risk, demand risk, forking risk, cryptography risk, regulatory risk, concentration risk, electronic trading risk and cyber security risk. Each of these risks are described in more detail in our in-app Product Disclosure. In addition to these general risks, we note that as with any DeFi protocol, Aave presents a slightly elevated short history risk relative to more established cryptocurrencies like Bitcoin. Further, the Aave community is not under any legal or regulatory obligation to disclose material information to the public regarding its activities. Holders of AAVE have no recourse to Aave or Wealthsimple if AAVE declines in value for any reason.
We emphasize that this Crypto Asset Statement is not exhaustive of all risks associated with trading AAVE. Investors should perform their own assessment to determine the appropriate level of risk for their personal circumstances.
WDA is offering Crypto Contracts in reliance on a prospectus exemption contained in the exemptive relief decision Re Wealthsimple Digital Assets Inc dated June 18, 2021. Please be aware that the statutory rights of action for damages and the right of rescission in the securities legislation of each province and territory of Canada would not apply to a misrepresentation in this Statement.
Last updated: July 26, 2021