"What We're Building is Very Big and We Should Have the Least Concentration Possible:" Aave's Stani Kulechov
This week’s episode is with Stani Kulechov the founder and CEO of Aave. When we spoke Aave was the second-largest DeFi protocol, but in the days after our conversation, it rose to overtake MakerDAO and become the DeFi platform with the most assets held in its smart contracts, at over $1B in digital assets.
It’s been an exponential rise for Aave, which launched just eight months ago and in that short time was able to climb the famous Defi Pulse Total Value Locked ranking to the top. It’s done so pushing DeFi forward by driving innovation in interest-generating tokens, flash loans and delegated credit lines, which are all lowering the barriers of entry to users from all corners of the world to access financial applications.
We also get into all the recent yield farming craziness, which he wishes was more restrained. Stani believes projects should build communities first, which can help fund audits, before launching protocols into the wild and risk losing users’ funds. There’s no trade-off between safer launches and fast growth; he believes DeFi can attract an even larger amount of users and funds by providing safer applications. If it doesn’t, it will end up losing credibility and users’ trust.
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Camila Russo:Before we get into all the latest developments, I'd love to get more of the background on how Aave came to be. Because before Aave, there was ETHLend and the ICO and going through all the roughness of the bear market. Can you find provide that background on the period before Aave?
Stani Kulechov: Definitely. As a protocol, we started Aave this year in January. We rebranded to Aave, but before that, we used to go by the name of ETHLend, which is short for Ethereum lending. What Ethereum lending was back then was just a small project that I founded while I was studying law in the University of Helsinki, Finland where I’m originated from. What actually happened is that we started as a community project and we wanted to create, the first lending protocol on Ethereum and test how we could create a bit more complex financial transaction than trading or transferring funds from one address to another.
One thing led to another, we had an interesting market back then and this was ages before stablecoins or liquidity pools or an idea of total locked value. I think, the transition from ETHLend to Aave was natural, as we saw liquidity starting to pull together and we started to think how we could utilize more of this locked liquidity, locked value in a more capital-efficient way. And that is how we came up with the Aave protocol.
CR: Because was ETHLend more of like a peer to peer lending structure than a pool liquidity structure?
SK: We started back then with the peer to peer model, because we heavily believed and still believe in the idea of decentralized finance, and for us, it was just financing in terms of smart contracts, because the term wasn't coined back then yet. But the idea is that you could actually democratize a bit interaction, so anyone can build permissionslessly and participate permissionslessly into the ecosystem. That is what's very fascinating.
We choose the peer to peer model also, because we try to separate risks as much as we could. Back then, the tokens that were on Ethereum, for example, didn't have that much liquidity, so we didn't want to go with a systemic model. Now, we see many models, in terms of liquidity pooling, whether it's trading or lending, that is actually a functional model if you have incentives network for liquidations, and these incentives that will ensure that your protocol will be healthy. That's why we transferred from one model to another as we saw it coming, the thing to do.
CR: Got it. And I thought, when you first launched, it was interesting to see that you were innovating right off with the A tokens, building from what Compound had done with C tokens, but modifying that structure a little bit. Can you explain, when you launched Aave, what were the main things that you were trying to innovate with at the time?
Interest-Gaining Tokens
SK: I'm a really big fan of the C tokens. What I wanted to do with our team is that with A tokens we wanted to somehow make interest-bearing tokens in a way that you could actually understand how much you're earning in terms of what you're depositing. Our goal was just to focus more on the end-user experience. For example, if I deposit 100 DAI into the Aave protocol and I get 100 A DAI as an interest-bearing token in return. We wanted to have this one-on-one ratio so that you could actually understand how much is deposited, but also that whatever you're earning in the protocol, it actually grows with the balance.
This means that we integrate we added into the A token smart contracts and an algorithm that is based on interest rate model of the protocol, which updates the balances of all of the A token holders. You will constantly see if you're holding A token Metamask or in some other basic wallet, you will see the balance all the time increasing.
Why it's important is that you actually know how much you're earning and also, it gives you access to a global permissionless savings account, which is dollar-denominated at the moment with the DAI, USDC and USDT A token versions. That's very important in places, for example, like Venezuela, other countries in Latin America. Argentina is a good example where you could just by holding A tokens, by depositing or by buying them, you hold this permissionless access to savings account this way. It's quite interesting, especially if your local currency has high inflation. I think in one way, it really democratizes and shows what you could actually do with DeFi with just this small interesting function.
“… it really democratizes and shows what you could actually do with DeFi with just this small interesting function.”
CR: I agree. For those listening or reading who are not that familiar with these types of tokens, it's a super interesting concept, which is representing a lending deposit or tokens deposited in a lending protocol with tokens in your Metamask wallet or in your Ethereum wallet. It’s a derivative of your token deposits. But what's interesting is that the token itself starts growing in value as you start gaining interest, so that's why they're called interest-gaining tokens. It's really cool that it does democratize access to a dollar savings account for anyone in the world. Aave and Compound are two main lending protocols offering these types of tokens.
From launch early in the year, value locked in Aave has completely skyrocketed. What do you think are the main milestones in this trajectory?
Image source: DeFi Pulse
Flash Loans
SK: We weren't expecting this traction at all. I mean, DeFi in general has been growing quite a lot above my expectations. I always projected DeFi to grow a lot based on things people have been building, what Aave has been building, what others have been building. What I see now is that we get more and more adoption. It's just funny because we're still in the very, very beginning, in the sense that there's many things that can be still built. We will probably see quite interesting DeFi primitives on top.
“We're still in the very, very beginning, in the sense that there's many things that can be still built. We will probably see quite interesting DeFi primitives on top.”
The biggest milestone for us was to see flash loans to get utilized, because in the beginning, we started to introduce the functionality to developers that, hey, you could build very interesting DeFi compressibility things which means, you take a couple of DeFi building blocks. Let's say you use Aave, you use Compound and Uniswap and you make a product and you use flash loans to reduce the need of actually capital to do a transaction.
We saw a few months ago that actually flash loans started to get a lot of traction. Now on a daily basis, we have quite a lot of flash loans and in some days, we have over $100 million worth of flash loans. That for me is very nice to see. Other things that have been substantially important to our team is the amount of developers that are building on top of Aave or are utilizing Aave and I think that's pretty cool stuff now. We’re trying to just innovate as much as we can, create new products and services and try to just make the DeFi experience as seamless as possible and get most out of it for the users
“Some days, we have over $100 million worth of flash loans.”
stani.eth 👻 @StaniKulechovHoly fuck, someone did 14 mm Dai flash loan, biggest ever on @AaveAave 🤯🤯🤯
sakulstra @sakulstraWith a slight delay a new version of https://t.co/cYPQpKRzA8 is available improving charts toggle functionality and re-rendering behavior ✨ @JakobSieversDK @SirSoth91 Btw. today @AaveAave broke another flash-record: https://t.co/NTBwNei7rp 14M $DAI in a single transaction ⚡️🤯 https://t.co/rY6nXkBHjF3:57 PM ∙ Aug 29, 2020165Likes24Retweets
CR: I wanted to expand a bit on the flash loans concept, which again, for those listening, it's a really interesting idea or ability for DeFi users to take out a loan on one Ethereum transaction, use that money borrowed to execute any type of trade in any other DeFi protocol outside of the platform that you took out the loan to begin with, and then pay back the loan on the same transaction, potentially with the profits that you made from whatever trade you're doing.
This needs to be automated and requires some level of skill, because you need to code these trades up. But it does allow anyone to participate in the system without having that much capital to start out with, because you're executing these trades with money that's borrowed. You get to keep those profits as long as you pay the loan back in the same Ethereum transaction. Let me know, Stani, if that was a good explanation for it.
SK: Totally. I think that was exactly, very good explanation. Flash loans are a functionality that mostly now maybe developers are using. There are ways to use it with no code functionality. For example, there's an app called Furucombo that does that you can actually just drag and drop and make functionality there it meant.
It's all about developers building new products for end-users to make them capital-efficient transactions in Ethereum. I think that's the key point where we are with flash loans. Flash loans are just a functionality, but it's part of the bigger picture of Aave protocol, utilizing capital as efficiently as we can with innovation.
“It's all about developers building new products for end-users to make them capital-efficient transactions in Ethereum.”
One of the other things amongst flash loans and A tokens is credit delegation that we announced a while back ago. That allows anyone who deposits into Aave to earn interest to delegate their credit line to someone they trust or to a smart contract that does some functionality, some strategies that are pre-programmed, there's less risk of failure.
This is the idea of average here, we calculated that every fourth user always depositing into Aave or let's say from the capital, 20% is somewhat utilized and the rest, 75% is available liquidity for flash loans or non-utilized. The credit delegation was a way of increasing that utilization rate by allowing other people that don't have collaterals but are in trust relationship or building some smart contract functionality to actually draw that credit on behalf of others. For depositors that are actually delegating credit, for them, it's pretty cool because they can earn additional yield and that's very interesting.
CR: That's very cool. I thought this was a really innovative concept and the way to get around this dilemma in DeFi, which is that up until now, you need a lot of capital to borrow, all of the loans in DeFi are over-collateralized. The reason why that happens is because for the system to be permissionless, you can't be checking somebody’s credit score or doing KYC or demanding like salary on the income statement or anything like that, it just needs to depend on the money you have. That's limited the number of users that can actually use DeFi because you're requiring to have money up front.
But this is a way to get around that; by delegating. If you have capital, you can delegate that collateral, so someone else can take on an unsecured loan. What I don't get is, how does the person who is delegating their collateral know how trustworthy the borrower is?
Credit Delegation
SK: That's a good question, because it boils down to the actual lending facility or lending model where you are entering into trust relationship. There’s an interesting scenario because there’re different kinds of trust relationships. People lend money, for example, for their family members, friends, so there's some trust. There’re others that are doing the same, but they're lending out to, let's say, consumers, businesses based on the risk borrowing.
As a function the credit delegation idea is to open the floodgates to delegate that credit and source DeFi liquidity out of protocols like Aave. But end of the day, about the underwriting, it's an opportunity for different kinds of protocol models or business models to create functionality where they can do some sort of creative risk assessment, for example.
I think, three very easy scenarios are where you're delegating credit lines to someone you can trust. You can even do that with just a verbal agreement, formal agreement with Open Law that we used, for example, with the very first delegation to diversify. The second way is you can use the very same thing. But you could, for example, a group of persons or delegators, could delegate to an entity that could be in the traditional finance, so they could delegate them to borrow stablecoins that they convert into fiat and then they lend it out, into their clients.
I could see that in the future, for example, our objective will be fulfilled, if someone in the street who bought a car or who bought a house, partially of that purchasing power is sourced from DeFi with credit delegation. It doesn't like the underwriting, it's one own form of business model. There is a project called UnionTello who are actually working on this stuff where, they're trying to bring efficiency in terms of underwriting loans in the decentralized finance and utilizing them. But I think we will see like a lot of various differences.
“Our objective will be fulfilled, if someone in the street who bought a car or who bought a house, partially of that purchasing power is sourced from DeFi with credit delegation.”
The third one, which is actually even more fascinating to me is that you could actually delegate credit to a smart contract that does some functionality. For example, we have a protocol called yEarn and one of their vaults, so they have vaults that are doing some sort of strategy, trading, yield farming, and one of the vaults is based on A lend token, which is delegated token of the A tokens to that vaults and that wallet draws credit line with the delegation from Aave. And that's a good example to have, I think, like farming activities.
CR: I'm not sure I got it, but first, let's go over the other examples. In the first case, which is kind of the simpler case is that you're delegating your borrowing power to people you know, like your friends and family. Then there's the second case, which I think is a way to scale up this operation is for entities to delegate their borrowing power to their own clients. So, for example, fintechs in traditional finance, who already do KYC on their customers and know that they are creditworthy, they can delegate their lending power and allow those customers, to borrow through Aave?
SK: Exactly.
CR: Then the third option would be for smart contracts execute that loan. You made this example with vaults in yEarn, but I didn't get that part of the example.
Smart Contract Borrowers
SK: What's interesting about this is delegating to a smart contract, you could delegate to a smart contract that can only do predefined functions. Let's say you have yEarn, you're delegating your credit to the yEarn vault and what happens there is that you give the permission of that vault to draw a credit line against your deposits into Aave.
When the vault functionality is called, it draws credit from Aave and deposits those funds into for example, Curve to yield farm and a smart contract can't do anything else, so that's the beauty of it. Because it's a predefined strategy, it's immutable and you're reutilizing the capital that is looked in Aave, in functions that can't be changed and eliminates the credit risk there. It's different from lending to people that you trust or under legal agreements. Because actually, the more you create different functionalities in smart contracts that are defined, the more DeFi grows and these opportunities will come, we might see more into this direction.
I really love when we have smart contract-based infrastructure and we don't need to go to, let's say, legal agreements and enforcement. For me, it's very fascinating what's happening on the smart contract side.
“… the more you create different functionalities in smart contracts that are defined, the more DeFi grows and these opportunities will come, we might see more scaling into this direction.”
CR: These loans would be used to execute different trading strategies by smart contracts. That's really interesting. Are there any examples of this happening yet? Or is it just something that you think would be a good way to use this functionality?
SK: Yes, smart contract-based credit delegation is already utilized by yEarn. So, they're drawing credit lines from Aave and depositing into different protocols, stablecoins to generate more yield and that's already happening. I will bet that this will be expanding in the future as well. I think I made the first proposal, I think was yesterday into the yEarn community where actually we could create more of these vaults and they expand the credit delegation in those strategies. It’s pretty interesting to see how it will develop.
CR: How much would you say right now is being borrowed through this mechanism in general, taking all these different strategies?
SK: I think the amounts aren't that big at the moment, I think we have, I’m not sure quite the number, because I haven't checked how much the utilization is there. But I would expect somewhere below one million still. It might be more, it's really, I haven’t checked how utilized it is, but it's interesting to actually follow how it's going to develop.
CR: As with so many things in DeFi, these things tend to grow exponentially and just pick up from one day to the next.
SK: We always tend to focus on the permissionless aspect of the users.But what's happening in the permissionless aspect in DeFi in terms of development, that's even more interesting because anyone can develop these products. I could imagine the future in Aave governance that someone could propose these vaults and there could be a credit delegation functionality that could be done in the user interface to choose which vault you want to delegate and what yields they give you. I could imagine the Aave governance voting on what vaults can be approved into the system, depending on their security, depending on their risk assessment and so forth.
CR: Speaking of governance, I wanted to also speak about Aave v2 and transition to more decentralized governance. Would love for you to give an overview of this upgrade of the protocol.
SK: Now what's interesting is the extra narrative behind, because when we launched in January and we saw the protocol growing over time, and currently, we have roughly $1.4 billion of locked value into smart contracts and the market size is even bigger, and so forth. We see the stakes are very high and we feel that as a team, we cannot anymore govern the protocol in the sense that we have at the base layer of the infrastructure.
[ … ]
Paid subscribers have access to the full transcript, including sections on:
- Aavenomics “When the Aave token holders are deciding upon this risk, they're also at the same time bearing the risk.”
- Aligned token holders’ incentives “Our goal is, when a liquidity provider steps into the Aave protocol, they are incentivized enough to keep the healthiness of the protocol in mind and see the protocol as a long-term investment for them.”
- Decentralized governance “You can't call it decentralized until you as a team can be challenged on every single decision you make or proposal you make.”
- Safer launches “I see there's more potential in actually building communities first and then building the product and then launching. Because the community will help your product build and that's a substantial help.”
- Sustainable growth ““If something (bad) happens, the industry stalls a year or two and that will be very shameful (…) I would like to see that the space will grow in a healthier direction. If you take the healthier path, it doesn't mean that we are going to grow slower.”
- Decentralized ownership“In my experience, honestly, the investors and the team, they don't need as much as they think. Because what we're building is very big and we should have the least concentration possible (…) You don't want to hold that responsibility. You don't want to be responsible for vast amount end-user funds.”
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About the founder: I’m Camila Russo, author of The Infinite Machine, the first book on the history of Ethereum. 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.
