Despite a decline in TVL of 76.5% from its 2022 record of $19.4 billion, Aave now has about $4.6 billion spread across seven chains on its platform.
Even the most robust DeFi protocols were burned by the 2022 bear market. In order to supplement Aave's current features and enhance income flows to the Aave Decentralized Autonomous Organization (DAO) Treasury, the Aave community approved a governance proposal to build and deploy an Aave-native stablecoin — GHO — during this stress test.
But first, what does Aave actually accomplish for the uninitiated?
Describe Aave.
Stani Kulechov, the company's creator, created Aave as a peer-to-peer (P2P) lending and borrowing market to simplify the circulation of cash in the market. In late 2018, they announced the creation of a parent company called Aave, which was named after the Finnish word for "ghost." Aave Gambling, Aave Lending, and other new products were also introduced as a result of the change.
Instead of peer-to-peer lending, Aave used pool-based lending, in which lenders deposit assets into a pool and borrowers borrow from that pool. This was further expanded in Aave V2 and V3, which included new features including isolated pools to better control risks, a high-efficiency mode to optimize capital efficiency when borrowing against identically pegged assets, and cross-chain borrowing and lending through Aave's Portal. These characteristics, together with Aave's early start, helped them become the fourth largest DeFi DApp and a crucial part of the DeFi ecosystem.
In addition to DeFi, Aave has created and released Lens Protocol, a decentralized social media platform that enables content producers to mint their profiles as interoperable NFTs while still retaining control of their work.
Aave's choices, like those of the majority of sizable DeFi DApps, are mostly determined by governance proposals and DAO votes. The GHO project, a native stablecoin to the Aave ecosystem, received approval from the governance in July 2022.
What Is GHO?
GHO, an overcollateralized stablecoin by Aave, is named after the term "Ghost." Like other stablecoins, GHO is created when a user deposits assets into the protocol, in this instance Aave V3. Yet, with permission from the Aave Governance, other Facilitators (protocols or companies) will be able to mint and burn GHO without any doubt.
The quantity of GHO that may be minted on Aave v3 is constrained by the amount of collateral that is placed. Users can mint GHO utilizing a variety of collateral options. Similar to conventional loans, Aave will liquidate the provided collateral to repay the loan if it falls below the defined liquidation threshold. If the borrower is not liquidated within the loan term, they must return the GHO plus interest in order to release their collateral from the pool.
The price of GHO on Aave is fixed at $1 with the current GHO design. As a result, GHO can retain its peg through arbitrage possibilities. Users are encouraged to manufacture GHO when it trades over $1 since $1 in collateral will produce 1 GHO, which is worth more than $1. At the same time, this increases the supply of GHO, driving down the price to the peg. When the price of GHO falls below $1, on the other hand, borrowers have an incentive to purchase GHO on the open market in order to satisfy their loan obligations. This action also decreases the supply of GHO, driving up the price of the commodity.
Due to the fact that GHO is created and burned by Aave, it lacks a supply side, hence interest rates cannot be set by demand, as is the case with other assets on Aave. As a result, the Aave DAO determines the interest rate for GHO loans, which may be changed by a vote of the governance board.
AAVE token holders on Aave's Safety Module additionally get a reduction on the interest rate on GHO loans in addition to the mechanics of GHO's peg. AAVE tokens that are staked in the Safety Module can be sold to offset the shortfall in the case of bad debt on the platform. This functionality was recently developed by AAVE. Stakeholders who bear the risk are compensated in return.
How Does This Affect Aave?
Borrowing costs are paid to the Aave DAO Treasury, which then enables the DAO to execute and fund future Aave functionalities. As developers get paid from the Aave DAO Treasury in a bear market, this is very crucial.
Conclusion
The debut of GHO might be important for Aave, even though their new stablecoin concept isn't exactly ground-breaking. Even with modest predictions, GHO borrowing fees may possibly generate millions more in revenue for Aave.
It won't be long now that GHO has been released on the Goerli Testnet, and we'll see how it affects the Aave ecosystem when it goes live on the Mainnet.
This essay is not meant to be financial advice and should not be taken that way.
