Aave Lending Protocol Complete Tutorial

Aave is one of the largest decentralized lending protocols, allowing you to deposit cryptocurrency to earn interest or use assets as collateral to borrow other tokens. This tutorial will guide you through using Aave and managing risks.

What is Aave?

Basic Introduction

Aave is a decentralized lending protocol built on blockchain. Unlike traditional banks, Aave uses smart contracts to automatically handle deposits and loans without intermediary approval.

Aave Features:

• Permissionless: Anyone can use it
• Over-collateralized: Borrowing requires collateral worth more than the loan
• Auto-adjusting rates: Change in real-time based on supply and demand
• Multi-chain support: Ethereum, Polygon, Arbitrum, and more

Aave vs Traditional Banks

How Aave Works

Liquidity Pool Model

Aave uses a "liquidity pool" model:

1. Depositors put tokens into the liquidity pool and earn interest
2. Borrowers take tokens from the pool and pay interest
3. Interest rates automatically adjust based on pool utilization

Interest Rate Mechanism

Aave has two types of rates:

Supply APY (Deposit Rate)

• Interest depositors receive
• Higher when more people borrow

Borrow APY

• Interest borrowers pay
• Choose between "stable rate" and "variable rate"

Health Factor

Health Factor measures borrowing safety:

Health Factor = (Collateral Value × Liquidation Threshold) / Borrowed Amount

• Health Factor > 1: Safe
• Health Factor ≤ 1: Will be liquidated

Assets Supported by Aave

Aave supports various crypto assets, each with different parameters:

Major Stablecoins

Major Crypto Assets

Terminology:

• LTV (Loan-to-Value): Maximum borrowing ratio. 80% LTV means $100 collateral can borrow up to $80
• Liquidation Threshold: When collateral value falls to this ratio, you get liquidated

Practical Guide: Earning Interest by Depositing

Step 1: Preparation

1. Prepare a Web3 wallet (like MetaMask)
2. Ensure your wallet has the tokens you want to deposit
3. Prepare enough ETH for gas fees

Step 2: Connect to Aave

1. Go to app.aave.com
2. Click "Connect Wallet" in the top right
3. Select your wallet and authorize the connection

Step 3: Choose Network

Aave supports multiple networks—choose what suits you:

Step 4: Deposit Assets

1. Find the asset you want to deposit on the Dashboard
2. Click the "Supply" button
3. Enter the deposit amount
4. First-time deposits require "Approve" authorization
5. Click "Supply" to confirm
6. Confirm the transaction in your wallet

Step 5: View Earnings

After depositing:

• You'll receive aTokens (e.g., aUSDC)
• aToken balance automatically increases over time
• This represents your deposit + accumulated interest

Practical Guide: Collateralized Borrowing

Why Borrow?

Common borrowing reasons:

1. Avoid selling: Bullish on ETH but need cash—borrow stablecoins instead of selling ETH
2. Leverage trading: Use borrowed funds for more investment
3. Tax optimization: Borrowing isn't selling, potentially avoiding capital gains tax

Step 1: Enable as Collateral

1. Find the "Collateral" toggle next to your deposited asset
2. Turn it on to enable as borrowing collateral
3. Requires one transaction confirmation

Step 2: Borrow Assets

1. Find the asset you want to borrow on the Dashboard
2. Click the "Borrow" button
3. Select rate type:
   • Stable rate: Higher but stable
   • Variable rate: Fluctuates with market, usually lower
4. Enter borrow amount
5. Confirm Health Factor is in safe range
6. Click "Borrow" and confirm transaction

Borrowing Example

Suppose you have $10,000 of ETH to use as collateral:

Liquidation Mechanism Explained

What is Liquidation?

When your Health Factor drops to 1 or below, part of your collateral is sold to repay the loan. This process is called "liquidation."

How Liquidation Works

1. Trigger condition: Health Factor ≤ 1
2. Liquidation amount: Usually 50% of the borrowed amount
3. Liquidation bonus: Liquidators receive 5-10% discount on collateral
4. Remaining assets: Collateral left after liquidation still belongs to you

Liquidation Example

You collateralize 10 ETH ($20,000) and borrow $14,000 USDC.

ETH price drops from $2,000 to $1,700:

• Collateral value: $17,000
• Health Factor ≈ 0.99 (below 1)
• Liquidation triggered!

After liquidation:

• ~5 ETH liquidated to repay $7,000 debt
• Liquidator receives ~5% bonus
• You're left with ~4.5 ETH and $7,000 debt

How to Avoid Liquidation

1. Maintain high Health Factor: Recommend keeping above 1.5
2. Set up alerts: Use DeFi Saver or other tools to monitor
3. Prepare emergency funds: Ready to add collateral anytime
4. Don't max out borrowing: Leave safety margin
5. Check regularly: Especially during market volatility

Advanced Features

Flash Loans

One of Aave's most innovative features, allowing uncollateralized borrowing that must be repaid within the same transaction.

Use cases:

• Arbitrage trading
• Debt refinancing
• Liquidation operations

Note: Requires writing smart contracts or using specialized tools, not suitable for regular users.

E-Mode (High Efficiency Mode)

When borrowing and collateralizing highly correlated assets, you can get higher LTV.

For example:

• Collateralize stETH, borrow ETH
• Can get 90%+ LTV (instead of usual 69%)

Automation with DeFi Saver

DeFi Saver is a DeFi management tool that can:

• Automatically add collateral to avoid liquidation
• Automatically adjust leverage ratios
• One-click transfer DeFi positions

Aave Stablecoin (GHO)

GHO is Aave's decentralized stablecoin:

Features:

• Minted by borrowing against Aave collateral
• Borrow rate determined by Aave DAO
• Usually lower rate than borrowing other stablecoins

Risk Management

Risk Checklist

1. Liquidation Risk

   • Collateral price drop can trigger liquidation
   • Solution: Maintain high Health Factor, set up monitoring

2. Smart Contract Risk

   • Although Aave has been audited multiple times, vulnerabilities may exist
   • Solution: Don't invest all assets

3. Interest Rate Risk

   • Variable rates can spike suddenly
   • Solution: Consider using stable rates

4. Oracle Risk

   • Price oracles may malfunction
   • Aave uses Chainlink, relatively reliable

5. Liquidity Risk

   • In extreme situations, withdrawals may not be possible
   • Solution: Don't depend on funds you need urgently

Risk Management Strategies

1. Diversify: Don't put all funds in Aave
2. Conservative borrowing: Keep Health Factor above 2
3. Use stablecoins: Reduce price volatility risk
4. Monitor positions: Check regularly or set up automatic alerts
5. Understand liquidation: Know at what price you'll be liquidated

Yield Maximization Strategies

Strategy 1: Stablecoin Deposits

Simplest strategy:

1. Deposit stablecoins like USDC, DAI
2. Earn 3-10% annual yield
3. Almost no price volatility risk

Strategy 2: Recursive Borrowing

1. Deposit ETH as collateral
2. Borrow stablecoins
3. Buy more ETH with borrowed stablecoins
4. Repeat depositing

Effect: Amplifies ETH exposure (similar to leverage)

Strategy 3: stETH Leverage

1. Deposit stETH
2. Enable E-Mode
3. Borrow ETH
4. Swap ETH for stETH
5. Earn the stETH staking yield spread

Frequently Asked Questions

Q: Can I withdraw deposits anytime?

Usually yes. But if pool utilization is too high, withdrawals may temporarily be unavailable. This is rare.

Q: Is there a loan term?

No. You can hold the loan indefinitely as long as Health Factor stays above 1. Of course, you need to keep paying interest.

Q: How do I repay?

1. Find your loan on the Dashboard
2. Click "Repay"
3. Enter repayment amount (can choose to repay in full)
4. Confirm transaction

Q: Can I pay only interest?

Yes. You can choose how much to repay—you don't have to repay everything. But recommend periodically checking accumulated interest.

Q: What's the difference between Aave V2 and V3?

V3 main improvements:

• E-Mode high efficiency mode
• Isolation mode (new asset restrictions)
• Portal cross-chain lending
• Better risk management

Recommend using V3 unless specific assets are only on V2.

Summary

Aave is a powerful decentralized lending protocol:

Aave is suitable for:

• Those wanting higher deposit interest than banks
• Long-term crypto holders needing liquidity
• Those who understand DeFi risks and can accept them

Things to note when using Aave:

• Must understand liquidation mechanism
• Maintain safe Health Factor
• Don't invest more than you can afford to lose
• Monitor your positions regularly

We hope this tutorial helps you understand how to use Aave. Remember, DeFi has risks—operate carefully!

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Want to learn more DeFi strategies? Continue reading:

• Uniswap Tutorial
• Liquidity Mining Guide
• Staking Beginner's Guide