The working principle of Aave
Aave is a peer-to-peer lending service. This means that the money that users borrow from the platform is made available by other users. There are no third parties in the system. Aave uses an algorithm to determine the lending rates and matches lenders and borrowers. The award works via a smart contract system. These smart contracts are code that is automatically executed under certain conditions.
The way Aave works could also be described as a peer-to-smart contract. The money is first lent to a smart contract and secured in it, the lender receives interest in the form of AAVE tokens. If necessary, users can borrow money from these smart contracts. An algorithm determines which smart contracts fit the needs of the user and what the interest rate is. The liquidity of the smart contract, for example, plays a role in the calculation.
In order to be able to borrow money from Aave, users must first deposit collateral. This is to guarantee that users are able to repay the loan. Aave has a liquidation threshold at which a portion of the collateral posted can be automatically sold to cover the loan. This is the only way to ensure user liquidity in the face of high cryptocurrency exchange rate volatility.
A notice: Users can borrow cryptocurrencies from Aave indefinitely, as long as they have deposited sufficient collateral. However, the interest rate increases over time.