How Aave V3 Works: A Retail DeFi Guide

High Efficiency Mode (E-Mode)

Aave V3 allows borrowers to maximise their borrowing power when using highly correlated assets as collateral. Users can opt into an E-Mode category (e.g. USD stablecoins or liquid staking derivatives) which boosts the Loan-to-Value (LTV) ratio for that category. For instance, in the stablecoin E-Mode category, you can borrow up to ~97% of your collateral's value in another stablecoin (versus ~75% LTV normally). By restricting borrowing to assets in the same category, the protocol grants a higher LTV and lower liquidation threshold since the assets move in tandem.

Bottom line: E-Mode lets you borrow more against your collateral within the same asset class, greatly increasing capital efficiency.

Isolation Mode

Aave V3 introduced Isolation Mode to safely list newer or riskier assets as collateral. When an asset is designated "isolated," it means if you use it as collateral, you can only borrow certain stablecoins (approved by governance) and only up to a debt limit. No other assets can be used as collateral alongside it. This containment limits potential damage from volatile or unproven assets.

Example: If you supply a new token in Isolation Mode, you might only be able to borrow USDC/DAI up to, say, $5M total – protecting the rest of the platform from that asset's risk.

Supply and Borrow Caps

V3 allows the community to set caps on how much of each asset can be deposited or borrowed. These caps prevent any single asset from growing too large in the pool (which could increase risk or affect protocol solvency). Caps are especially useful for mitigating risks like infinite mint glitches or oracle manipulation attacks on a given token.

Gas Optimisations

V3 made technical improvements to reduce gas costs for using Aave on Ethereum and other chains. Actions like deposits, borrows, and liquidations are more gas-efficient than in V2, saving users fees. These optimisations make Aave more usable on Layer-1 and also facilitate cheaper use on Layer-2 networks.

Cross-Chain Portal

Aave V3 introduced a feature called Portal that enables cross-chain liquidity movement. Users can deposit in one network and then essentially teleport their liquidity to another chain's Aave market (by burning aTokens on source and minting on destination). This is facilitated via approved bridge protocols.

1. Connect a Wallet

Visit the Aave app and connect a Web3 wallet (e.g. MetaMask). Ensure you're on a supported network (Ethereum by default, or switch to Polygon, etc. as needed).

2. Deposit an Asset (Supply)

Choose a cryptocurrency you want to lend (for example, USDC stablecoin or ETH). Click "Supply" and enter the amount. Submitting this transaction will deposit your asset into Aave's pool. In return, you'll receive aTokens in your wallet (e.g. aUSDC) representing your deposit – these automatically earn interest. You can supply multiple assets if you want to diversify your lending.

3. Enable Collateral (Optional)

If you plan to borrow against an asset you supplied, you must enable it as collateral. In the Aave dashboard, there's a toggle for each supplied asset to mark it as collateral. Toggle on the asset(s) you want to use to borrow. (Some assets, like isolated ones, may be automatically set as collateral or have restrictions.)

4. Check Your Borrow Limits

Aave will show your borrowing power based on the collateral you enabled. It also shows a health factor, which starts at "∞" if you have no loans. This will drop as you borrow – keep it comfortably above 1 to avoid liquidation.

5. Borrow an Asset

Now navigate to the "Borrow" section. Here you'll see assets available to borrow and the interest rates (variable and/or stable rate). Select the asset you want to borrow (e.g. perhaps you deposit ETH and want to borrow a stablecoin like DAI). Enter an amount within your allowed limit – Aave will show the max you can borrow based on your collateral and the asset's LTV. It's wise to borrow much less than the max (e.g. <50% of your limit) to maintain a safe buffer. Submit the transaction to borrow.

6. Use Your Loan (and Earn on Deposits)

Once borrowed, you can use those funds for anything – trading, yield farming, or simply hold them. Meanwhile, your deposited collateral continues earning interest. If you borrowed a different asset than you deposited, you effectively have liquidity without selling your original holdings (e.g. keep exposure to ETH while borrowing stablecoins to spend).

7. Monitoring and Managing

Regularly check your health factor and the values of your assets. If your collateral value drops or your borrowed asset's price rises (relative to collateral), your health factor falls. You can adjust by repaying part of the loan or adding more collateral to raise the health factor. Aave's interface gives a colour-coded health meter; treat anything close to 1.0 as high risk.

8. Repay and Withdraw

When you're ready to close your position, go to "Repay". Select the asset you borrowed, and repay the amount (note: you can't withdraw collateral until corresponding debt is repaid). After repaying (including all accrued interest), your borrowing power frees up. You can then go to your supplied assets and "Withdraw" whatever you supplied (plus interest earned).

1. Stablecoin Lending for Passive Yield

One of the most popular low-risk strategies is lending stablecoins on Aave to earn interest. Stablecoins (like USDC, DAI, USDT) are pegged to fiat currencies (e.g. $1), so their value is stable – making them ideal for earning yield without exposure to crypto price volatility. By depositing stablecoins into Aave, you can earn an APY that often beats traditional bank savings rates or money market funds.

For example, Aave's USD stablecoin market is often seen as the "base rate" in DeFi, with rates fluctuating based on demand. In mid-2025, Aave's USDC deposit rate ranged roughly from 5-10% APR (variable) depending on market conditions. This interest comes from other users borrowing those stablecoins (perhaps traders or yield farmers), who pay interest to lenders.

To execute this strategy: Simply supply stablecoins (USDC, DAI, etc.) to Aave and let them sit and accrue interest. It's a set-and-forget approach – ideal for a DeFi "savings account" on idle cash. You can withdraw anytime if you need the funds.

2. E-Mode Loop (Leverage) Strategy

For more advanced users, Aave's Efficiency Mode (E-Mode) opens the door to leveraged yield strategies, sometimes called looping. The idea is to deposit an asset and borrow more of the same (or similar) asset, repeatedly, to amplify your exposure or yield. Thanks to E-Mode's high LTV, you can loop many times.

Silo Finance (Isolated Lending Pools)

Silo takes an almost opposite approach to Aave's shared pool. Instead of pooling all assets together, Silo creates separate lending markets for each asset, isolating risk so that an issue with one token doesn't affect the others. In Silo, every asset is paired with a common bridge asset (like ETH or a stablecoin) in its own "silo."

For example, there might be a separate pool for TokenX <-> ETH, another for TokenY <-> ETH, and so on. If TokenX experiences a hack or a price collapse, only the TokenX silo (and its ETH bridge) are impacted – not the whole protocol. This design prevents cross-contamination of risk and allows Silo to list long-tail (more experimental) assets that Aave might not touch.

Trade-off: The trade-off is liquidity fragmentation: capital is split into many small pools rather than one big pool. Aave's model is more capital-efficient (lenders and borrowers aggregate in one place, so there's deep liquidity), but it means all assets in that pool share risks. Silo's model is more secure per asset but less efficient.

Maple Finance (Institutional Lending)

Maple is a different beast – it's often described as "DeFi's Institutional Lender." Maple's platform focuses on under-collateralised loans to institutional borrowers (like trading firms, market makers, etc.), which is a contrast to Aave's fully collateralised, permissionless model.

In Maple, you typically have KYC-gated pools managed by Pool Delegates who assess borrowers. Lenders (often also accredited or institutional) deposit into these pools to earn yield from loans made to known companies. Credit risk replaces collateral – borrowers might post some collateral, but loans can be partially or even mostly unsecured, based on off-chain credit agreements.

For lenders: Yields on Maple can be higher to compensate for credit risk – double-digit APY is common (e.g. Maple's Blue Chip pool was offering ~12% and a riskier pool ~17% APY in 2024). These are notably higher than Aave's typical ~5-10% on stablecoins at the time. However, that yield comes with the risk that a borrower may default.

Aave V4 Hub-and-Spoke Architecture

There is a central Liquidity Hub on each chain that holds all deposited assets, and multiple Spoke contracts that plug into this hub to facilitate specific types of lending/borrowing markets. Users interact with Spokes (e.g. a main pool or a special interest pool), which draw liquidity from the shared hub. This unifies liquidity (improving capital efficiency for lenders and borrowers) while isolating risk within each Spoke's rules.

Each Spoke can have custom parameters (for example, a Spoke optimised for stablecoins, or an isolated market Spoke for a new asset) and the hub enforces overall limits to ensure no Spoke can endanger the whole system.

Expected Advantages

• • Unified Liquidity: All deposits on (say) Ethereum will sit in the Ethereum hub. No more fragmentation between "Aave ETH market" and "Aave Polygon market", etc., on the same chain.
• • Specialised Markets: Spokes can be created for different purposes without affecting each other. For example, one Spoke might mimic the current "main market" with a variety of assets.
• • Risk Isolation with Liquidity Sharing: This architecture aims to combine the strengths of shared and isolated models. Because each Spoke is isolated in terms of risk, Aave can safely incubate new innovations.
• • Developer Friendly & Extensible: The Aave team has indicated V4 will be more modular – anyone can build a Spoke. This could unleash creativity: communities or third parties might launch Spokes tailored to niche markets.

Q: Is Aave V3 safe for beginners?

A: Aave V3 is designed with many safety mechanisms (like health factor monitoring, conservative risk parameters, and audited smart contracts). For beginners, lending stablecoins or blue-chip assets on Aave is generally considered a lower-risk way to earn interest in DeFi. The main thing is to avoid complex strategies until you're comfortable. Start by depositing a small amount and seeing how it works. Always keep an eye on your health factor if you borrow. While no platform is 100% risk-free (smart contract exploits or stablecoin issues can happen), Aave's track record so far is excellent, and it has a large community and governance process focusing on risk management.

Q: What's the difference between variable and stable borrow rates on Aave?

A: When you borrow on Aave, you often can choose a variable interest rate or a stable interest rate. A variable rate fluctuates with market conditions – if lots of people borrow that asset, the rate goes up, and vice versa. A stable rate is an attempt to offer a semi-fixed rate: it's set higher than the current variable rate and won't change with small market fluctuations, but it can adjust if the variable rate moves a lot or if certain conditions are met (so it's not a guaranteed fixed rate forever, but it's more predictable in the short term). Variable rates are usually lower initially and better if you plan to borrow short-term or think rates will drop. Stable rates are good if you want certainty and are holding a loan long-term.

Q: What happens if a stablecoin I lent or borrowed depegs?

A: Aave relies on price oracles to determine the value of assets. If a stablecoin (supposed to be $1) loses its peg significantly, a few things can happen. If you borrowed that stablecoin and its price shoots above $1, the value of your debt (in USD terms) increases – that could lower your health factor and potentially cause liquidation. If you lent that stablecoin and it crashes below $1, the value of your collateral drops, which could also threaten your position if you borrowed against it. Aave's safety modules might kick in for extreme cases – for instance, governance might freeze a market or adjust parameters – but those are not immediate.

Q: How does Aave make money?

A: Aave's revenue comes from a portion of the interest paid by borrowers. When you see an interest rate on Aave, borrowers pay that, and lenders receive slightly less – the difference is Aave's reserve factor. For example, if borrowers pay 5% APY on an asset and the reserve factor is 20%, lenders might get 4% and Aave's protocol reserve earns 1%. These reserves are used as a backstop (insurance) and can be claimed by AAVE token governance or used to burn AAVE, etc., depending on governance decisions. Additionally, Aave introduced a fee on flash loans (a one-time fee for borrowing with no collateral within one transaction) – currently 0.05% of the flash loan amount goes to the protocol.

Q: Can I use Aave V3 on Layer 2 solutions or only on Ethereum?

A: Aave V3 was deployed not only on Ethereum mainnet but also on several other networks, including Layer 2s and sidechains. At launch, it went live on Polygon, Avalanche, Arbitrum, Optimism, and others. By 2025, Aave V3 is on a wide array of networks – from Arbitrum and Optimism (popular Ethereum L2s), to Avalanche, Polygon, Fantom, and even newer chains like Base or zkSync Era as they gain traction. Using Aave on those networks is very similar to using it on mainnet, but you'll enjoy lower gas fees and sometimes different asset selections.

Q: What is the AAVE token used for? Do I need it to use Aave?

A: The AAVE token is the governance token of the Aave protocol. If you hold AAVE, you can vote on proposals that affect Aave (like adding new assets, adjusting parameters, deploying new versions, etc.). AAVE also has a role in Aave's safety module: AAVE stakers backstop the protocol against deficits – they earn rewards but could be slashed if there's a shortfall event. As a normal user, you do NOT need AAVE token to lend or borrow on Aave – you can interact with the protocol purely with the assets you want to lend/borrow. Aave doesn't charge a platform fee token or anything. Think of AAVE like the "ownership/share" of the platform. But it's entirely optional for using the platform's core functions.

Q: How does Aave compare to Compound?

A: Compound is another pioneer of DeFi lending. Aave and Compound are often compared because both offer pooled lending and over-collateralised borrowing. The main differences as of V3 are features and asset support. Aave tends to list more assets (especially long-tail assets via Polygon, etc., and now via Isolation Mode) whereas Compound kept a narrower set of major assets. Aave introduced features like flash loans, stable rate borrowing, and of course the V3 enhancements (E-Mode, Isolation, cross-chain, caps) – Compound's recent versions have added some similar concepts. In usage, Aave's UI and flexibility is often praised, while Compound is known for simplicity. Interest rate models differ slightly, but to an average user they feel similar (supply APR, borrow APR that adjust with utilisation). Both are solid, but Aave has grown larger in TVL and tends to innovate faster now. Still, Compound might offer better rates on certain assets at times or be preferable if you trust its minimalist approach more.