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What is Aave?

Aave is a decentralised platform wherein depositors and borrowers can participate in the non-custodial liquidity market protocol. Depositors provide liquidity to the market to earn a passive income, while borrowers borrow in an over collateralized or undercollateralized manner.

The digital assets are allocated in a smart contract wherein the on demand withdrawal of funds takes place and a tokenized version can be exported.

Well, aTokens make all of this possible! In simple words aTokens are the interest bearing tokens of the Aave Ecosystem.

aTokens

aTokens are minted when they are borrowed and burned when they are redeemed.  These tokens are pegged 1:1 to the value of the deposited asset.  A key point to be noted here is that the users can freely store, transfer and trade aTokens such as aDAI!

When the asset deposited in the Aave protocol is provided to the borrowers in the form of loans, these aTokens accrue interest in real time. Moreover, this accrued interest is directly deposited into your wallet. Hence, any sort of complications and time delays are completely ruled out. This way you can witness your balance grow each minute!

Here are some salient features of aToken-

1.  One to one ratio - aTokens are pegged one to one value of the asset deposited in the Aave protocol.
2. Redirecting the interest - The interest which is accrued and earned by the aTokens can be transferred or redirected to any Ethereum public address at any time!
3. Stablecoins - Since Aave also involves Stablecoins, the users can always opt for stablecoins such as aDAI, aUSDC, aUSDT and subsequently earn interest on them!

Similar to using any other crypto asset on Ethereum, aTokens can also be moved and traded.

Depositing and earning

In order to make a deposit in the Aave protocol, users can simply go to the "Deposit" section and click on "Deposit" for the asset to be deposited.Thereafter, the amount is selected and transaction is submitted. Here, any amount can be deposited, there is no minimum or maximum limit. The interest would begin to accrue as soon as the transaction is confirmed and the deposit is successfully registered. 

Borrowing

The prerequisite to avail the borrowing services at Aave DAO is the presence of any asset in the form of a collateral. Thus, before borrowing the users need to deposit any asset to be used as collateral. Thereafter, via the Borrow section, asset to be borrowed and asset to be used as collateral can be selected. The transaction can then be completed by selecting either stable or variable rate.

Governance in Aave 

The primary aim of the Aave protocol is to create a dynamic, adaptable, safe and sustainable network of markets which are regulated by not only protocol-wide but also market-specific policies. The governance protocol abides by the specific set of policies prescribed by Aave. The policies are defined and validated through a governance process that bestows token holders with the right to make all the decisions in future. 

Aave opted for a gradual and formalized path to the decentralization of the Protocol. It aims to bring together various stakeholders within the Aave ecosystem by covering governance mechanisms and financial incentives.

Proposals(AIP)

The Aave Improvement Proposals(AIPs) are one of the most significant components of a DAO. In this section of the article, we would explore the types of proposals, the prerequisites to create a proposal and the life cycle of the proposals.

Requirements to create a proposal

The power of creating a proposal is defined by the snapshot of that account's AAVE or stkAAVE balances in addition to the balances of all the delegators. The delegators can delegate the proposition power to another account. The voting powers can also be delegated. In order to create a proposal, the proposition power should be higher than the Proposition threshold, before the proposal creation, until the proposal execution.

Types of proposals

There are primarily two types of proposals in Aave DAO. They are explained as follows-

Affecting Governance Consensus

These are the relatively critical proposals which require comparatively more time for voting.They are usually related to the governance. The execution of these proposals is done by long time lock executor.

Affecting Protocol Parameters

This proposal is executed by the short time lock executor. Only certain parameters of the protocol get affected by this type of proposal. Since these proposals require less voting time, they are ideal incase quick action is needed. 

Lifecycle of a proposal

Prior to the creation of a proposal, the AIP and the ARC process needs to be followed.

The Aave request for comments (ARCs) needs to be submitted on the governance forum. The AIP refers to the Aave improvement proposals which need to be submitted via Github and should contain all the required information about the forum discussion and snapshot vote.

Proposal Creation

For the creation of a proposal the create function can be called. The proposer must possess the minimum percentage of the voting token supply needed to submit a proposal.The created proposal remains in the pending state until the voting starts.

Voting on Proposal

When the proposal becomes active, the votes can be submitted by the users. However if there is a voting delay, the voting procedure would begin after that. Voting delay can be evaluated by calling the get voting delay function.

End of the voting period

In order to SUCCEED ,the votes in favor should exceed the minimum quorum parameter, which refers to  the minimum percentage of the voting token supply of the votes in favor and the vote differential parameter which refers to the percentage of the voting token supply of 'for' votes needed over the 'against' votes.

The proposal would be declared FAILED if this criteria is not met

Queuing and execution of the proposal

Before the expiration of the grace period, A SUCCEEDED proposal can be queued.In this case this proposal would be executed after the execution delay.

The time lock executor authenticates and executes the proposal.

Any user can cancel the proposal, if the power of the proposal creator decreases and fails to meet the proposition threshold. Moreover,a guardian account which is controlled by the Aave Genesis team can cancel a proposal prior to its execution.

Voting

In order to vote you need to possess either AAVE tokens or stkAAVE (Staked AAVE) tokens. You can use both of them. The amount will be added on in your voting. An important point to be kept in mind while voting is that your vote would be valid only if your balance of voting tokens must be the same or greater throughout the entire proposal voting period.

AAVE and stkAAVE token holders possess governance powers proportionally to the sum of their balance.

Initially there are two powers associated with each governance token-‍

1. ‍Proposal power - The proposal power gives access to create and maintain a proposal.‍
2. Voting Power - The voting power is used to vote for or against existing or new proposals.
   

Any user can choose to delegate one or both of the governance powers associated with a token, either by the medium of the governance portal or programmatically.

AAVE - The Governance Token

AAVE, the governance token, is used to vote and decide on the outcome of Aave Improvement Proposals (AIPs). Apart from this, AAVE can also be staked within the protocol Safety Module for the provision of security and insurance to the depositors.

The AAVE token is an ERC-20 compatible token which is used in the tracking of the governance balance. It integrates EIP 2612 permit function which further facilitates gas-less transactions. Moreover, stakers earn staking rewards and fees from the protocol. 

AAVE Tokenomics

Let us have a look at the tokenomics of the Aave token. Interestly, there are 16M AAVE tokens! Around 3M tokens are owned by the founding team and are allocated in the aave ecosystem reserve. Currently, 12.5M are a part of the market supply. 13 million AAVE tokens will be redeemed by the LEND holders. 

The AAVE token serves two prime functions

1. Governance 
2. Securing the protocol. 
   

The token holders who stake the coin avail the opportunity to participate in the operating decisions and ongoing discussions of the platform. Currently, only 22% of the AAVE token holders stake their token. Furthermore, token holders who stake the coin get to participate in the security module. By opting this, they can earn a yield of 7%. 

AAVE vs LEND Token

The LEND token is the native token of the Aave protocol. It is open source and is based on Ethereum. It facilitates effective borrowing and lending in the aave platform. It is also capable of being converted to the aave token. It is also supported on the Binance platform.

The conversion or migration ratio of LEND to AAVE  is 100 LEND to 1 AAVE. In simple words 100 LEND is equivalent to 1 AAVE, so if 100 LEND is migrated 1 AAVE would be available as a result. Likewise, incase 1 LEND is migrated 0.01 AAVE would be received. For instance-

1.  222349 LEND to 2223.49 AAVE 
2. 0.7 LEND to 0.007 AAVE 
3. 37 LEND to 0.37 AAVE.

Safety Module and It's Incentives

Aave portrays a highly sagacious methodology to keep its protocol secure and incentivizing the members at the same time.This mechanism persuades the members to actively participate for effective governance.

The AAVE holders are required to lock their tokens into the Safety Module for which they are incentivized! And this further becomes the primary mechanism of securing the protocol. It combines the best of both worlds, incentivizing the members and securing the protocol.

The safety incentives

The Aave holders are incentivized to participate in the Safety module and contribute to the safety of the protocol by depositing their Aave in the safety module. This mechanism indirectly helps incase of a shortfall event. The AAVE locked by the holders is used as an alleviation tool to mitigate the downturn in case a Shortfall Event arises in the Aave ecosystem. 

There is a period of 7 days, called the cooldown period, wherein the tokens can not be claimed. However, the fees which is generated by the Aave protocol for the participants of the safety module can be withdrawn anytime as per the need.

Thereafter, redistribution of this fees to the SI participants takes place.

The shortfall events and The safety mechanism

A shortfall event is a situation in the Aave market wherein a deficit or a shortfall is incurred, (hence the name). The safety module of Aave protocol is designed to cater to all sorts of shortfalls incurred. Let us examine how the safety module works incase of a shortfall event.

A portion of the locked AAVE are auctioned on the market on the occurrence of a Shortfall Event. These previously locked Aave tokens are sold against the assets needed to mitigate the incurred deficit.  Also, The safety module has a backstop mechanism so as to prevent the excess flow of AAVE into the open market. This is done to avoid any reduction in value which could be witnessed incase of an excess flow.

The holders of the deposited AAVE tokens can redeem their share from the module at any time, Please note that this would trigger a cooldown period of one week which can be further extended via the governance.

The fees generated by the protocol are consistently allocated to the users participating in the safety module. This allocated fee can also be withdrawn.The reward plan for the Safety incentive is designed to incentivize participants who contribute to the safety of the protocol in the primary phase. 

One important point to be noted here is that all the fees distributions are only potential in nature until they go through AIP process and governance vote.

When safety module fails to revive the loss

In such a scenario wherein the Safety module is not able to cover all of the deficit incurred, the Protocol Governance is empowered to trigger an ad-hoc Recovery Issuance event. 

In this case, new AAVE is issued and sold in an open auction.

What can we learn from Aave DAO?

Gradual and planned decentralisation

 Aave entailed a formalized path for decentralization and autonomy by introducing its governance token- the AAVE token. In the initial phase, the migration of LEND token to AAVE token marked the commencement of transferring the governance power from the core team to the token owners. We infer that Aave DAO opted for gradual, planned and organized decentralization.

Safety Module and Incentives

This is a great example in which we can see the token holders supporting the protocol by staking their holdings to cover any risks, and the protocol in-turn rewarding the token holders who participate in staking. This is a true decentralization and leads to very stable systems.

Systematised, effective and decentralized governance

Aave implements and executes the governance mechanism quite effectively, efficiently and dynamically. Here, the governance and voting model is based on the ownership of AAVE tokens or stkAAVE (Staked AAVE) tokens.

References

https://docs.aave.com/faq/flash-loans

https://docs.aave.com/aavenomics/safety-module

https://docs.aave.com/aavenomics/policies#safety-incentives-si 

https://docs.aave.com/aavenomics/ecosystem-overview

https://docs.aave.com/developers/protocol-governance/governance#proposition-voting-power

https://www.youtube.com/watch?v=2BP_PqSMWIk&t=357s

https://medium.com/aave/exploring-new-frontiers-with-aave-59563ddd2405

https://docs.aave.com/governance/

https://www.binance.com/en-IN/support/announcement/17595222999545348c8acdd5dc41c00a

https://www.coindesk.com/markets/2020/07/17/aaves-lend-token-is-now-up-1600-in-2020/

https://docs.aave.com/aavenomics/

https://medium.com/coinmonks/a-detailed-study-of-the-aave-platform-and-token-1310908b8a08

https://medium.com/aave/aavenomics-eeab650cccc2