Aave launched a market yesterday which will allow users to deposit liquidity provider (LP) tokens from automated market makers (AMM) and use them as collateral for borrowing.
The market, called AMM Market, initially accepts deposits for 14 of Uniswap’s, and two of Balancer’s LP tokens. It has over $5M currently locked in its smart contracts without liquidity mining, as Aave CEO Stani Kulechov pointed out to The Defiant.
Further decisions about which collaterals and protocols to support will soon be transferred to Aave’s governance process, according to the team’s Twitter account.
At this time, users may borrow DAI, USDC, ETH, wBTC, and USDT against their collateralized LP tokens.
A Virtuous Cycle
“LP tokens as collateral enable liquidity providers to gain leverage on that yield,” Nik Kunkel, backend engineer at MakerDAO told The Defiant, explaining what the development means for DeFi.
The functionality actually has “a positive feedback loop between all DeFi participants,” Kunkel said, “AMMs get more liquidity, LPs gets more yield, credit protocols like Maker and Aave earn more fees, and traders get less slippage.”
As LP tokens provide more money-making opportunities, more users will provide liquidity to AMMs in order to deposit them in protocols for leverage. The leveraged tokens can be deposited back into AMMs resulting in less slippage, increasing the overall utility of DeFi.
Put succinctly, enabling LP tokens to be used as collateral “makes capital more efficient,” Kulechov told The Defiant.
Building on Proof of Concept
The Aave team has already built a market for AMM tokens before. Last May they shipped a market with similar functionality, but which only accepted Uniswap version 1 LP tokens as collateral.
With proof of concept established, Aave has moved on to a more flexible market, with a theoretically unlimited amount of LP tokens available as potential collateral.
The AMM market will not initially be covered by Aave’s Safety Module, which serves to offset lost funds by selling locked AAVE tokens, though governance can vote to change this.