Is Aave the Golden Decentralised Loan Protocol?

Introduction

Aave, formerly known as ETHLend, is a decentralised non custodial lending and borrowing protocol based on the Ethereum blockchain.

They have launched their mainnet beginning of January 2020 and offers so far three products:

  • Stable interest rate ERC20 loans: lenders deposit ERC20 supported assets by the protocol and receive a minted aERC20 (a for aave), which is still a ERC20 token representing the asset lent, but with continuously compounding interest attached to it.

  • Variable interest rate ERC20 loans: same principle as the above, except that this is based on a variable interest rate, which will change depending on supply and demand for the asset lent.

  • Non-collateralised Flashloans: these are loans, which do not need any collateral when taken, but have to be borrowed and repaid in the same transaction. Otherwise, they do not execute. These flash loans offer the possibility to take advantage of the DeFi market inefficiencies.

These three products are useful, I’m not going to explain how you can use them, there are tons of articles exactly doing this. But I would say one thing: Flashloans are a goddamn idea.

Flashloans & Inefficiencies

These loans permit to take advantage of inefficiencies arising in the market, such as for arbitrage, self liquidation and so on, but not only for “market” inefficiencies. Indeed they can be used to profit, grossly speaking, from “DeFi inefficiencies”.

DeFi inefficiencies are linked to protocols or projects, which took shortcuts to build their project, such as take Uniswap price oracle instead of ChainLink oracle, when a lot of people knew that UniSwap oracle was easily manipulable for certain currencies, and so on and on.

But the good thing is that DeFi is only started. And it must improve on all fronts if it wants to bring in new users, which are too scared to put their money in, due to these issues.

Aave with Flashloans contributes to make DeFi a safer place in the long term.

The products are innovative but are there any people actually using Aave and shall we care about the LEND token? I dig into the numbers starting with TVL.

Total value locked

Total value locked approaches $40M USD and has seen a continuous high growth rate since the protocol starting date, beginning of January 2020. From $0 to $40M in three months and a half is impressive. To put things in perspective, Compound had $86M locked in beginning of January and now has $91M, so almost no growth in TVL for Compound over the same period.

Analysing the Aave blockchain

Transactions per day

In terms of transactions, we can clearly see two phases highlighted respectively in grey and green. These two phases correspond to the before and after go live date of Aave mainnet. We can clearly see that the mainnet had a meaningful impact on the blockchain’s activity.

However, we can also notice that for April, the protocol has started to lose steam. Transactions are falling as reflected by the simple moving average which has never be so low after mainnet launch. That might be due to lower interest rates across the board and people not willing to lend their assets for a 1-2% return.

Active users per day

Active users per day are measured by addresses interacting with the smart contract, as opposed to people who have visited Aave’s website, for example.

Aave’s protocol is used by a lot of different users. We have calculated that between the mainnet launch date and April 14th 2020, there has been 45 days where more than 50 active users interacted with the smart contract.

This is interesting because it shows that Aave’s protocol is used by more than only a few initiés. It does really work and is useful to many DeFi users.

Risks

We see one main risk for Aave’s future, besides the traditional competition from other protocols such as Compound.

The interest rate to lend and borrow tokens is low and this is a risk to lending/borrowing protocols. Imagine lending your crypto and get 2% for doing so. It is still better than traditional finance though but it is not the same as in the golden age, where you could make a 10% return for lending DAI.

We do believe it constitutes a risk going forward as it might cut the current existing users from using the platform to lend their tokens and they could look for other way to make money out of DeFi.

However, low interest rates might be also seen as an opportunity for risk lovers such as speculators, as it is easier to take leverage longs or shorts with a low borrowing rate. So it will drive more demand, and as a result, lending rates might improve as well and not drop further.

Valuation

It is difficult to come with a valuation method for a protocol which is a few months old and where token economics are currently being reviewed by the team itself and are about the change.

However, Aave already provides a return for LEND token holders in the form of coin burns. Once in a while, there are burns occurring on the protocol.

It is a simple and effective way to reward existing LEND holders by burning LEND tokens, so the supply decreases and the price should mechanically increases, if the demand stays constant.

Since mainnet live date, Aave has burned 1,315,646.65 LEND tokens, currently priced at $0.0217, which is worth $28,549 USD.

We could go and make an annualisation and then divided it by total supply and calculate a P/E ratio but we are not going to because we do not have enough data to build an accurate indicator. However, what we do know is that LEND token is currently one of the most profitable token thanks to its coin burn.

Conclusion

As seen in the above research, Aave is a working protocol, which is used by many people to lend and borrow ERC20 tokens in a decentralised way on the Ethereum network. The project also rewards token holders with coin burns and TVL continues to increase.

We also do see the lower interest rate to lend as a short term risk to the current business model, as current users might not be interested to lend their assets anymore on the protocol.

However, the lower interest rate might only be temporary, as leveraged trades are about to pick up in DeFi soon, with the graces of Synthetix and Futureswap. Other protocols such as dYdX and Nuo might as well play catch up in the future. The key here is to offer the highest lending rate.

To sum up, Aave’s mainnet has been successful and is one of the big winner in the Defi ecosystem, in terms of user adoption, product innovation (Flashloans) and token price appreciation.

As both DeFi users and investors, we continue to see Aave as one of the top innovator in the space and look forward to see their enhanced v2 token economics and new products.

Thanks for reading

Secret Salsa

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