"People Aren't Earning Anything in Their Bank Accounts; Let's Bring Them to DeFi:" Aave's Stani Kulechov

Hello Defiers! Happy start of the week to everyone. This week’s Monday Interview is with Stani Kulechov, the founder and CEO of decentralized lending platform Aave. After much anticipation from the DeFi community, Aave launched on mainnet last week with a series of innovations, including “flash loans,” which are issued and repaid within the same Ethereum block, without the need of collateral, and fixed rate collateralizes loans.

Stani says he envisions flash loans as a tool for developers to build mind-blowing tools for the end user and enable entrepreneurs to continue building new DeFi projects without requiring as much capital up front. He believes the DeFi narrative will change from value locked, to how this value is being used, and that flash loans are one way to use this locked capital more efficiently. He also talked about what’s next for Aave, with governance at the forefront in terms of profuct, while also a Series A round with VCs coming up down the line.

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On the Aave Launch

Stani Kulechov: We were kind of ready already in Devcon, but still wanted to just improve a bit then. Then we had like a second trial before the holiday in December, and we still wanted to kind of tweak and polish it and eventually we decided to do it now. I think this is better than anything else. It was very tiring process. But now you finally see it and it's amazing.

Camila Russo: Congrats! A little bit more on the process. How long did it take to build, how many people were in your team? What were kind of the biggest challenges?

SK: We released the latest version of EthLend last year in January or March and we understood that pooled models were a very good way to arrange liquidity, and then we started building the Aave protocol. So it took quite a lot of time and effort.

We are not that big a team but we aren’t small. We're roughly 20 people here. Half are basically developers and related to product and everyone else is a bit kind of like support and research. The skill set that we have is pretty nice. Everyone has done great job and have grown with the process. We feel as a team and as individuals feel we actually know a lot about what we're doing. And that wasn't the case like a year and a half, two year ago. We are based in London and we have another office in Switzerland.

Image source: Aave website

Background and Crypto Red Pill

CR: Before we get into more of the details of the platform, I wanted to go back and ask about your background. Can you tell me a little bit of what you were doing pre crypto and what got you into crypto?

SK: To be honest, what got me into crypto was pretty much Ethereum. I knew always that there was Bitcoin around. But the thing with Ethereum was that with smart contracts you can create more complex transactions, and remove custody, and have code that can't be changed. That's super powerful. In college I started to try to explore a bit more what you can actually create. And back in the day there wasn't DeFi, there wasn't actually anything there. I think there was like prediction markets with Augur. There was a time when cryptographic tokens started to have a secondary market in centralized exchanges and a bit on dexes, but not that much.

And I was thinking, what could be cool is you could actually use this value as collateral and one of the interesting use cases for it could be lending. And I wanted to create something that's trustless with some value between the parties. That is where the collateral comes in. And then we just started to experiment. EthLend was the first iteration. And it was funny because back in the day when we launched, people were asking in a big Reddit thread and post why would someone borrow with collateral if they can sell or trade. And today there's half a billion dollars in DeFi.

Image source: Medium

CR: You said you were in college when when you started getting into Ethereum and building EthLend. So, you had no traditional financial job or non-crypto job before Aave?

SK: No. Well, I used to do some development when I was in my teen years, a few years. My background is legal, so I did some law-related work too. But I've always been interested and fascinated by finance, even in college I was more interested in finance than law and in general.

When you look at finance today, it's is pretty ineffective. What you have in your mind about what you want to do with finance, it can be very innovative. But you can't do any of those things in practice in the financial system. And for me that doesn't make sense. If I send funds to someone and someone needs to wait two, three or four days to receive those funds or any other kind of similar inefficiency. At some point I fell in love with financial instruments. I did a lot of research and tried to think about how we could actually reproduce those different kinds of financial instruments and remove all the inefficiency. I had this thought that you could have an internet of smart contracts that removes the base of trust between entities. And that was the vision.

CR: To round up the background part of your story, you said you were studying something related to law?

SK: Yes, I think I was in third year or so when EthLend was founded. I'm not a dropout, but I never graduated. I should graduate this year. Aave and EthLend basically came in the middle of my life and have opened a new world and it's just so exciting that it's difficult to do anything else, you know. It's not the first love, but I think it's like the true love, what the whole Ethereum space is for me. So it's just difficult to do anything else other than what we're doing now. I have an excellent team of people thinking similar ways to try to improve the financial ecosystem. It feels it's like a once in a lifetime opportunity and I just can't just go away from that.

CR: Can I ask if it's not a rude question, how old you are?

SK: I will be 29 on Monday [today]. This is the biggest present ever being able to launch before my birthday. I can't wish for anything else to be honest.

The Aave Idea

CR: Can you take me through the process of coming up with EthLend and how that led to Aave?

SK: We kind of kick started a bit the whole DeFi lending space. And after us there's been a lot of innovation and other different kinds of interesting projects out there improving what we did. What we are doing with the other protocols is basically improving what's there is now and not just improving but also giving new options for people. Because the thing is that we can't be too concentrated on doing something very similar because if you want to get more people into DeFi we need to have more offerings and more alternative offerings, different kinds of ways to establish interest rates, different kinds of risk models and different kinds of ways to build the protocols technically. When we have this diverse ecosystem, then we will be able to onboard more people and there's more trust there and different sorts of solutions.

With EthLend, is we decided to look at what's now working in DeFi, what others have been building, and let's try to figure out what's missing. And one of the main narratives was, we need to get yield for people. People are not earning anything in their bank accounts. We have to get those people to DeFi and, and show that there's yield here and other cool stuff that you don't normally get with your bank, like the non-custodial relationship and also transparency.

We also understood that there is now the assets locked. So if you look DeFi Pulse, what everyone is always talking about, which is like the narrative, how much assets are locked into DeFi protocols. But we tend to forget is that we need to always look a bit to the traditional finance and basically see how they're utilizing assets because otherwise we won't be able to compete. And it’s hard to compete, because they're doing it with a trust-based model.

Undercollateralized Flash Loans

To compete we need to actually utilize the assets in a better way and that's how we came up with the flash loans. So what we are trying to do with the flash loans functionality, which is basically, anyone can borrow undercollateralized loans from the protocol, do all kinds of transactions in the internet of smart contracts and return to funds and get extra yield in the protocol. We reuse the collateral. That's the next step in the DeFi narrative. We can't be just looking at how much we are locking, but how we are using those locked funds. How are we pulling out that liquidity?

CR: Can you go a little bit deeper into how flash loans work? I understand it's you take out a loan and you repay it on the same transaction, but what's actually going on there? And how long does the whole process take?

SK: Flash loans are pretty simple. There's a function in our smart contract called "flash loan" and basically when you call the function and you borrow from the protocol, there is a condition that says that if the loan is not returned on the same transaction with the fee, the transaction gets reverted. And because of the logic that we have, that basically means that you can do all kinds of different transactions. So it doesn't need to be just that you borrow.

The service that we are doing is ensuring that you can borrow and return and in between these, what we call circuits, you can do all different kinds of stuff. So for example, you can open a trade with that same liquidity in Uniswap, close another trade in Kyber or one of the most interesting use cases for me is for example, you take a Dai flash loan, close a CDP -- for example if you have a high-interest rate CDP but you see a lower rate somewhere else, you take the Dai, close the CDP, take the ETH, send it to the other lending protocol and draw the Dai from there and basically return the flash loan, everything on the same transaction, which basically means that you have just refinanced your client or yourself if you're doing it for yourself.

And you can also do it even more complex, like adding more things into the circuit. So you could actually swap currency. So let's say you are in a loan with a USDC in Compound. You could do the same thing in reverse, but also you change the USDC to basically Dai. And that way you just don't do the interest rate swap there, you are also doing the currency swap. This is what fascinates me. But I'm pretty sure that there's other people thinking way more complex or even more simple and workable things. That's the kind of logic how you utilize these loans. You can actually take as much liquidity as there is in the smart contract. So there's no cap in that and that can be done in every Ethereum block.

CR: Oh, nice. Okay but one block takes just a few seconds right?

SK: Usually in Ethereum each block is confirmed every 13 seconds, but the seconds are not that important. The block is. So whatever you do, you have to do in one block. Each Ethereum block basically settles the transactions in a certain way. So you can do all kinds of things, but there has to be finality inside of the Ethereum block. .

CR: Okay. So anything you do with the liquidity you take with a flash loan you have to do in 13 seconds.

SK: Yeah. Whatever you do, you have to return what you borrowed on the same block. So there is some different kinds of transactions that you can actually do and borrow liquidity. It's like flash liquidity in a way because you are just taking it to do some sort financing method.

So take the two young guys from India, who participated in the ETHIndia hackathon some time ago and built an easy way to do, for example, CDPs, with one transaction instead of the all the five or eight involved with InstaDApp. Those guys did a bridge where they enabled people to close their CDP and refinance your loan to Compound. And to be able to do that they had to borrow from Comopund, off-chain, and ask, I think it was between 300,000 and 500,000 pounds to do this operations, this refinancing.

These guys don't have that kind of money because they're just young developers with the vision is to build products. In a similar case, they could have used flash loans to borrow for this particular transactions without actually needing the capital. So if you think about the big picture of what we're trying to achieve is that we can get more developers building financial products without the need of the actual capital and that lowers the threshold. That’s how we can increase the types of DeFi offerings, and even more so with the huge composability there is.

CR: Amazing vision. What I still don't get is, you have to build some kind of bot or something to actually execute whatever you want to do with that liquidity within 13 seconds. Like no human can actually do that, right?

SK: Flash loans are we could say directly a developer tool. Because a developer can create a refinancing tool, or an arbitrage tool or just to liquidate CDPs for example. But at the end of the day it's always the end user who is benefitting.

Let's, let's say I'm a developer, I create a service and I'm using flash loans. Say the service is called liquidation service, and say you have a CDP open and it gets into collateral call. So when this collateral margin call happens in the Maker system, you're losing 13% as a liquidation fee. Say you took the CDP because you are long on ether, but you needed the Dai to spend in paying bills. So you already spent that Dai, and now there's a liquidation coming and you're losing 13% of the value that you have locked into Maker. Now what you can do as a developer, is build a product and says subscribe to this service and if your CDP is getting liquidated, a flash loan is taken and the loan is repaid before the liquidation happens. So then you save 13%, or maybe the app will get up 1%, and you keeps 12%. So the developer is building this product, but you could be the end user.

CR: So you envision flash loans being a tool for developers to make DeFi easier for the end user.

SK: Yeah, exactly. And not just easier. I would say they will also expand DeFi use cases because you don't need that much capital. And it also helps make things cheaper because it lowers the cost of the transactions. But of course that will take a bit of time and experimentation and we'll see how it plays out. But yeah, that's the core of what we're trying to achieve. So basically more DeFi products, more diverse DeFi products and basically more yields to the depositors and hopefully lowering the borrowing fees as well because there's more income coming into the pools. So that's the overall big picture of what we're aiming for.

Fixed Rate Crypto Loans

CR: I'd like to get into your other, other features too. You also have this ability to switch from a fixed rate to variable rate. What was the thinking and the innovation behind that?

SK: I'm glad you asked about this because, we want to change the narrative in the space and also give some attention to the consumption side. So we have all these people depositing funds earning interest, but we also need to acknowledge that there's other people that are utilizing and using those funds. We are trying to increase is the demand as well, and to increase it, we need to give more options for the end users.

We can't just offer variable rates, where let's say you are paying now 5% now, and during the night you might be paying 7%, depending on liquidity. And if one big entity withdraws liquidity the rate goes up. That's unacceptable for the end user, especially when we go to the retail side. And that's what we are trying to achieve is give retailers more options as well. And rate switching allows us to do that, allows us to give another alternative to the variable rates, where you have certainty and stability on your interest rates.

People who are uncertain on taking a DeFi loan because of the varying rates, now have more certainty. We expand a bit the scope on how we can onboard people. And you can always switch. Let's say you jumped into a variable rate and the rates started going up, you can jump very stable rate then and be there or if you see that the rates are going down, you can jump into a variable rate and you can switch on block by block basis as well.

CR: Is it always the option of the borrower to switch or does the system sometimes require for stable rate loans to upgrade to variable rate, or raise the interest because the whole market is increasing? So I get the idea of changing from stable to variable because rates are falling, but is there a case where it doesn't make sense for so many borrowers to have a stable, low rate when the whole market is increasing rates? Would the system force the borrowers to raise rates in that case?

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About the author: I’m Camila Russo, a financial journalist writing a book on Ethereum with Harper Collins. (Pre-order The Infinite Machine here). I was previously at Bloomberg News in New York, Madrid and Buenos Aires covering markets. I’ve extensively covered crypto and finance, and now I’m diving into DeFi, the intersection of the two.