Aave is a decentralized lending protocol where you can supply crypto to earn interest (currently 3-8% on stablecoins) or borrow against your deposits as collateral. No bank, no credit check, no application. You deposit ETH, borrow USDC against it, and pay interest by the second. If your collateral value drops below the liquidation threshold, your position is automatically sold to repay the loan.
What Is Aave (And How DeFi Lending Works)?
4 min read
The short version
Aave is a robot bank that runs on code. Lenders deposit crypto and earn interest from borrowers. Borrowers put up collateral (worth more than what they borrow) and pay interest. The key difference from a bank: everything is transparent on-chain, rates adjust every second based on supply and demand, and there is no human deciding whether to approve your loan. If the math works (sufficient collateral), you can borrow instantly.
How It Works
How Aave works step by step: Supplying (earning yield): you deposit tokens (ETH, USDC, WBTC, DAI) into Aave lending pools. You receive aTokens (aUSDC, aETH) that represent your deposit plus accruing interest. Your balance grows every second. Current supply APY: USDC ~4-6%, ETH ~2-3%, DAI ~5-7% (rates fluctuate with utilization). Borrowing: once you have supplied collateral, you can borrow other tokens against it. Each asset has a Loan-to-Value (LTV) ratio: ETH has 80% LTV, meaning $10,000 ETH collateral lets you borrow up to $8,000. You pay variable interest (adjusts every block based on pool utilization). Health Factor: the ratio between your collateral value and your borrow amount. Health factor > 1 = safe. At 1.0 = liquidation threshold. Below 1.0 = you get liquidated. Aave V3 shows this prominently. Liquidation: if your health factor drops below 1 (collateral lost value or debt grew), liquidation bots automatically repay part of your debt by selling your collateral at a 5-10% discount. You lose that collateral plus a penalty. This protects lenders from bad debt. Interest rate model: rates are algorithmic. Low utilization (few borrowers relative to deposits) = low rates. High utilization (most deposits are borrowed) = high rates. This naturally balances supply and demand without human intervention.
Depositing $10K USDC and borrowing $5K against ETH collateral
Scenario: you hold 3 ETH ($9,000 at $3,000/ETH) and want $5,000 cash without selling your ETH. Step 1: Go to app.aave.com on Ethereum or Arbitrum (cheaper). Connect wallet. Step 2: Supply 3 ETH as collateral. You receive aETH tokens (auto-earn ~2% APY on your collateral). Step 3: Borrow 5,000 USDC against your ETH. ETH LTV: 80%, so max borrow = $7,200. You borrow $5,000 (conservative, 55% utilization). Health Factor: 1.44 (safe, liquidation would not trigger until ETH drops ~30%). Step 4: You now have $5,000 USDC to use however you want, plus your 3 ETH still earning staking-like yield as collateral. You pay ~5% APR on the borrowed USDC ($250/year in interest). Step 5: Risks to monitor. If ETH drops from $3,000 to $2,100 (-30%), your health factor hits 1.0 and liquidation begins. Solution: either repay part of the loan before that happens, or supply more collateral. You can repay the 5,000 USDC at any time (no term, no penalty) to unlock your ETH.
What People Get Wrong
You can borrow without collateral on Aave
Standard Aave loans are overcollateralized (you deposit more value than you borrow). The exception is flash loans (borrow and repay within one transaction, used by developers, not regular users). There are no unsecured/undercollateralized loans for individuals on Aave.
If ETH goes up, your loan gets cheaper
If your collateral (ETH) appreciates, your health factor improves (safer position) and you COULD borrow more. But your existing debt (in USDC) stays the same regardless of ETH price. The loan amount does not shrink when collateral goes up. You still owe the same USDC plus interest.
Lending on Aave is risk-free yield
Risks include: smart contract bugs (Aave has been audited extensively but risk is never zero), liquidity crunches (if everyone withdraws simultaneously, you might face a queue), and governance decisions (Aave DAO can change parameters). The yield is real (paid by borrowers) and historically reliable, but not FDIC-insured.
Keep Reading
Sources & Further Reading
- Aave App
Official Aave lending interface for supplying and borrowing
- Aave Docs
Technical documentation covering all Aave V3 features
- DefiLlama Aave
TVL, yield data, and chain deployment tracking for Aave
Questions People Also Ask
- What is the minimum to use Aave?
- No minimum deposit. On Ethereum L1: gas costs ($5-$20 per transaction) make it impractical under $1,000. On Arbitrum/Optimism: gas costs $0.10-$0.50, making Aave practical for $100+ deposits. The protocol has no minimum; the economics depend on which network you use.
- What happens during liquidation?
- Liquidation bots repay up to 50% of your outstanding debt by selling your collateral at a 5% discount (liquidation bonus for the bot). You keep the borrowed tokens but lose collateral worth the debt repaid + penalty. Example: $5,000 USDC debt with $7,000 ETH collateral at liquidation. Bot repays $2,500 USDC by taking ~$2,625 worth of your ETH. Your remaining position: $2,500 USDC debt, ~$4,375 ETH collateral.
- Where does the yield come from?
- From borrowers paying interest. When you supply USDC and earn 5%, that 5% comes from other users borrowing USDC and paying 6-8% interest (Aave takes a protocol cut). It is real demand-driven yield from actual borrowing activity, not token emissions or unsustainable incentives.