KoinlyticsAave is DeFi's largest lending market. You supply an asset and earn interest; you borrow another asset by posting collateral. Everything is overcollateralized: you must post more value than you borrow, so the protocol stays solvent even if the collateral drops.
The interest rate model
Interest rates are set by a curve based on utilization (borrowed/supplied). Low utilization: low rates, plenty of liquidity. High utilization: rates spike quickly to attract more suppliers and push borrowers to repay. Aave uses a two-slope model with a kink around 80% utilization: below the kink, rates are gentle; above, they climb aggressively.
LTV, liquidation threshold, health factor
- Max LTV. Highest borrow you can open against a collateral. WETH is often 82%, USDC 85%.
- Liquidation threshold. The point at which liquidators can seize your collateral. Usually a few points above max LTV.
- Health factor. (Collateral value �- liquidation threshold) / borrow value. When HF < 1, you can be liquidated.
Liquidation mechanics
When your position becomes liquidatable, anyone can call the liquidation function. They repay part of your debt on your behalf and receive your collateral at a discount (typically 5-10%). The protocol stays solvent. You take a loss on the liquidated portion.
eMode: efficiency mode
Aave V3 introduced eMode. If both your collateral and borrow are in the same category (e.g. both stablecoins, or both ETH-correlated), you get higher LTV limits. Borrow USDT against USDC at 95% LTV. Loop stETH against WETH at 92%.
Isolation mode
For new or risky assets, Aave V3 allows them to be listed with a debt ceiling and only usable as sole collateral. You cannot mix them with other collateral. This lets the DAO onboard new assets safely without contagion risk.
Risks that show up in real cycles
- Oracle manipulation. Aave uses Chainlink. Historical exploits on other protocols were often bad oracle choice.
- Fast crashes. If ETH drops 30% in one hour, liquidators may not clear positions fast enough. Aave has a safety module (staked AAVE) as backstop.
- Governance risk. The DAO can list bad assets. Read new listing proposals.