Aave: The Development, Current Status, and Advantages of Decentralized Finance Protocols over Traditional Finance

Decentralized Finance (DeFi) builds a peer-to-peer financial system through Blockchain and smart contracts technology, aiming to eliminate centralized intermediaries such as banks, thereby dropping costs and process time. Among numerous DeFi protocols, Aave stands out as a leading lending platform.

Aave was launched in November 2017 by a team led by Stani Kulechov under the name "ETHLend" and was renamed Aave in September 2018 (which means "ghost" in Finnish). As a decentralized lending protocol within the Ethereum ecosystem, Aave allows users to collateralize one crypto asset to borrow another, while lenders can earn interest by providing liquidity. This article will systematically outline the development history and current status of Aave, and will compare its advantages over traditional finance in detail.

1. The Development History of Aave

• 2017: Stani Kulechov launched the peer-to-peer lending platform ETHLend, raising $16 million through an ICO. In 2018, ETHLend was renamed to Aave (meaning "ghost") and the original LEND token was swapped for AAVE at a 1:100 ratio.
• January 2020: The Aave V1 mainnet officially launched, introducing the liquidity pool model, allowing users to deposit crypto assets into the pool for other users to over-collateralize and borrow, thereby significantly improving capital utilization efficiency.
• December 2020: Aave V2 was released, further dropping transaction costs and adding new features such as batch flash loans. Among them, flash loans are the first innovative feature launched by Aave in 2020, allowing users to borrow funds without prior collateral, as long as they return the principal and interest within the same transaction.
• March 2022: Aave V3 was released, focusing on enhancing cross-chain capabilities and risk control. V3 supports multi-chain deployment, compatible with Ethereum Layer 2 networks (such as Arbitrum, Optimism) and other Layer 1 chains (like Polygon, Fantom, etc.). At the same time, V3 introduced cross-chain "Portals" functionality, allowing users to "deposit on the Ethereum mainnet, borrow on Polygon, and then repay on Avalanche," significantly improving asset liquidity and arbitrage efficiency.
• July 2023: Aave launched the native decentralized stablecoin GHO. GHO can be minted by collateralizing various assets, and all interest income belongs to the protocol DAO. In the same month, the Aave community also voted to integrate the USD stablecoin PYUSD issued by PayPal, taking a step towards collaboration with traditional financial institutions.
• Future (Expected in 2025): Aave will release version V4, introducing a new "Hub-and-Spoke" architecture. In V4, each network (such as Ethereum and various Layer 2s) will have a unified liquidity hub, with different "spoke" markets connecting to the hub and supporting configurations for special assets or strategies, thus breaking the liquidity island situation of various markets under V3. This architecture will further enhance capital utilization, simplify governance processes, and facilitate innovative products (such as dedicated markets for stablecoins, derivatives, or real assets).

As of May 2025, Aave's total value locked (TVL) has reached a new high, surpassing $26 billion, making it one of the leading lending protocols in the Decentralized Finance space.

V4 Highlights: A "liquidity hub" is set within a single chain, called by diverse "spoke markets," which maintains capital efficiency while supporting customized scenarios such as RWA, E-Mode, and Vault.

2. Current Status of Aave

Aave has now become a decentralized, non-custodial comprehensive liquidity protocol, allowing global users to act as liquidity providers (depositors) or borrowers across multiple networks. Its core functions include:

• Liquidity Pool: Users deposit crypto assets into the protocol's asset pool to earn floating interest; borrowers provide over-collateralization to obtain loans. Aave's algorithm dynamically adjusts deposit and loan rates based on market supply and demand, achieving a decentralized interest rate discovery mechanism.
• Flash Loan: Aave pioneered Flash Loan, allowing users to borrow without collateral as long as they repay in the same transaction. This mechanism supports second-level arbitrage, liquidation rescue, and complex combination trades, making it a unique tool in Decentralized Finance.
• GHO Stablecoin: GHO is the native decentralized stablecoin within the Aave ecosystem, allowing users to mint GHO by collateralizing crypto assets already deposited in the V3 market while retaining the interest generated from the collateralized assets. GHO is governed by the community, and the repurchase interest is used to replenish the protocol treasury, thus providing financial support for Aave's long-term development.
• Governance Mechanism: AAVE token is the governance token of the Aave protocol, and holders can vote in the Decentralized Autonomous Organization (DAO) to determine the direction of the protocol, such as introducing new assets, modifying parameters, and enabling new features. This community-driven governance ensures the transparency and autonomous evolution of the protocol.
• Cross-chain expansion: Aave has been deployed on the Ethereum mainnet and multiple chains such as Avalanche, Polygon, Arbitrum, Optimism, and Fantom. The interoperability and bridging design between the chains allow users to freely transfer funds and earn yields across different networks, demonstrating Aave's high adaptability and flexibility.
• Security Measures: The Aave protocol has been audited by several top security firms and has a bug bounty program to incentivize global white hat hackers to identify risks. In addition, Aave's Safety Module allows users to stake AAVE tokens, providing extra protection for the protocol; in the event of a funding shortage, the staked pool in the Safety Module can be used to cover losses, and stakers receive generous rewards.

3. Comparison with Other Lending Protocols

Conclusion: Aave TVL is still far ahead, but Morpho is achieving "catching up" through Vaults aggregation and collaboration with CEX scenarios. Compound, on the other hand, attracts institutional users with a single benchmark asset model.

Four, Advantages of Aave (DeFi) Compared to Traditional Finance

Compared to traditional financial systems that rely on centralized institutions, DeFi protocols like Aave have significant advantages:

• Decentralization and Intermediary-Free: Traditional lending relies on intermediaries such as banks and brokers, with cumbersome processes and high fees. Aave enables peer-to-peer transactions through smart contracts, eliminating the need for third-party approval and custody. Borrowing and repaying are automatically executed on-chain, allowing users to participate in global financial activities simply by connecting their crypto wallets, without credit checks or lengthy KYC processes.
• Openness and Inclusivity: Traditional finance often sets high thresholds, making it difficult for individuals without bank accounts or credit histories to access services. In contrast, DeFi platforms like Aave are open to any user with an internet connection, with no geographical restrictions. For example, users from around the world can borrow and lend cryptocurrencies through Aave at any time, without being constrained by bank branches or working hours.
• Transparency and Auditability: Traditional financial institutions often lack transparency, making it difficult for ordinary customers to understand internal processes and the flow of funds. In contrast, every transaction and flow of funds within the Aave protocol is recorded on a public Blockchain, and the protocol's code is open source and verifiable. Anyone can audit the logic of the smart contracts and all transaction records, ensuring the protocol operates transparently and is free from opaque operations.
• Efficiency and Instantaneity: Traditional loan approvals and cross-border payments can take days or even weeks, accompanied by high fees. Aave achieves instant matching and disbursement of loans through smart contracts, and flash loans can complete the borrowing process within a single block. This near real-time capital turnover significantly improves the efficiency of fund utilization, allowing users to access liquidity without long waits.
• Innovative Financial Tools: Aave continuously launches innovative products, such as flash loans that make uncollateralized arbitrage possible, and the high efficiency mode (E-Mode) which increases the lending rate of similar asset collateral to 98%. Its modular design also allows the protocol to seamlessly integrate with other DeFi ecosystems (such as Uniswap, Curve, etc.), giving rise to various strategies like cross-protocol arbitrage and yield aggregation, creating a product iteration speed far exceeding that of traditional finance cycles.
• User Control and Asset Autonomy: In traditional banking systems, customer assets are held in custody by banks and other institutions. In the event of a dispute or policy change, personal assets may be frozen or misappropriated. Aave, as a non-custodial protocol, ensures that users always hold the private keys, and funds operate solely according to the rules preset by smart contracts after being deposited into the protocol. This means that users have complete control over their assets without relying on any intermediary.

5. Challenges and Risks

Despite the many advantages of Aave, it also faces the following challenges:

• Smart Contract Risks: Vulnerabilities in DeFi protocol code may lead to theft or loss of funds. Although Aave has significantly reduced risks through multiple security audits and a bug bounty program, any software inevitably has potential flaws, and users should remain cautious.
• Market Volatility: The prices of crypto assets fluctuate wildly, and the value of collateral may suddenly drop, triggering automatic liquidation. Aave requires over-collateralization to ensure the safety of lending, but during severe market downturns, borrowing positions may still be forcibly liquidated. Although this liquidation mechanism maintains the stability of the protocol, it may also pose additional risks to ordinary users.
• Regulatory Uncertainty: The decentralized characteristics of DeFi conflict with the current regulatory framework. Existing financial regulations are mostly based on jurisdictional restrictions, making it difficult to cover cross-chain anonymous transactions. Future protocols like Aave may face compliance pressures, such as anti-money laundering (AML) and securities law requirements, and will need to find a balance between decentralization and compliance.
• Complexity of Use: For users lacking blockchain experience, the concepts and operational processes of Aave are relatively complex. For instance, flash loans and high-efficiency modes require an understanding of smart contracts and transaction principles, leading to a high learning cost. The high flexibility of the protocol also means a steep learning curve, which is particularly challenging for new users.

6. Future Outlook

Looking ahead, Aave will continue to lead through innovation.

Technical Level, the launch of Aave V4 will bring a new design: a cross-chain hub that unifies liquidity, and various specialized markets (Spoke) that provide services for specific asset groups. This architecture is expected to gradually be implemented in 2025, promising to further enhance capital efficiency and flexibility.

On the application level, Aave is actively collaborating with traditional financial institutions and emerging projects. For instance, at the beginning of 2024, the Aave community voted to integrate the US dollar stablecoin PYUSD issued by PayPal, exploring the interconnection between stablecoins and mainstream payment ecosystems; at the same time, Aave has supported bridging mechanisms to introduce stablecoins and real-world assets into the protocol.

In terms of regulation and competition, Aave needs to cope with the tightening global regulatory environment and strengthen compliance construction, while continuously innovating in the face of challenges from competitors like Compound and Morpho. Overall, as blockchain technology and the maturity of Decentralized Finance improve, Aave is expected to become a bridge connecting traditional finance and Decentralized Finance, providing global users with more democratic, efficient, and transparent financial services.