Aave Governance enacts policies on key parameters which are determined within the protocol. A policy is defined as a set of governance-defined rules that control specific aspects of the protocol or the individual markets.

Policies Set the Governance-defined Rules

At the higher level of abstraction, we can classify the policies as follows:

  • Protocol Policies: These policies govern the overall behaviour of the protocol and the entities belonging to it. They regulate specific aspects of the protocol related to safety, economics and expansion.

  • Market Policies: These policies are defined in the context of each market and, for markets belonging to the Aave ecosystem, they are specified within the boundaries identified by the Protocol Policies. A market participating in the Aave ecosystem needs to operate under safety policies that are not violating the protocol safety policies.

The governance of these Policies is the core function of Aave as a protocol for on-chain money markets.

Protocol Policies

Risk Policies

The Risk Policies define the set of rules that ensure the safety and protection of the protocol and the users participating in it. Risk Policies include, but are not limited to, decision-making for:

  • Assets compatible for integration within Aave: The list of assets for which risk is deemed acceptable for the safety of the protocol.

  • Modelling of the interest rates: Interest rates modelling is a key risk parameter as it determines the actual yield for depositors, the ratio between borrowed, available liquidity and the general the competitiveness of a market for a specific asset.

  • Base risk parameters for overcollateralization and liquidation: The risk parameters that are governed by AAVE affect all money markets and set global boundaries for those markets. The current methodology for the global risk parameters is presented in Aave’s risk documentation.

  • Configuration and behaviour of the Safety Module (SM): The Safety Module is one of the core components of the Aave Ecosystem which is regulated by a set of rules and behaviours.

  • Acceptance of new money markets: Anyone will be able to instantiate their own money market within the Aave Protocol. However, markets will be accepted under the Governance and secured by the Safety Module only if the Market Level Policies satisfy the constraints imposed by the protocol Risk Policies.

Improvement Policies

Improvement policies define rules under which ecosystem improvements are incepted, developed and applied to the ecosystem, including but not limited to:

  • Smart Contracts

  • Governance processes

  • Governance contracts

  • Safety Module

  • AAVE Token contract

Incentives Policies

Incentives Policies define the rules under which token incentives in Aave are generated. Financial incentives are used to shape behaviours within the ecosystem to achieve a common objective [11]. For Aave, the common goal is to ensure the safety of the Aave Protocol, cost-efficient usage by the market participants, and proper ecosystem incentives to drive innovation and long-term growth of the ecosystem.

Safety Incentives (SI)

Safety Incentives ensure the safety of the protocol by incentivizing AAVE holders to participate in the Safety Module. This is achieved with a set of incentives pushing behaviour to naturally create a positive feedback loop within the Aave Protocol. In that sense, the essence of those systemic incentives is to materially fade away while having lasting impact on participants behaviour [12]. This behaviour materializes with the birth of policy motivated agents that have incorporated the sustainability of the system they now belong to [13].

AAVE holders participating in the Safety Module earn both Safety Incentives in the form of AAVE and fees from the protocol.

Ecosystem Incentives (EI)

Liquidity Providers and Liquidators (in the form of a single user or as a DeFi end-user interface) are two key components of the sustainability of a decentralized finance protocol by enabling liquidity within the protocol. As stakeholders and maintainers of the Aave Protocol, they should be rewarded with governance power through the EI.

Market Policies

The Aave Protocol will eventually allow anyone to create a money market. However, to benefit from protocol incentives, the market parameters and assets selected must be within the realm of the Risk Policies.

The following list describes which parameters must be defined at inception by market creators in order to customize their own market:

  • Supported assets to provide liquidity and borrow from. The currency should be validated by the higher layer Protocol Governance.

  • Supported assets to use as collateral. In the whitelisting scenario, the currency should be already validated by the higher layer Protocol Governance.

  • Enable/disable borrowing modes of an asset. Variable, stable or any other mode included in the future in the protocol.

  • Market-specific components update. Smart contract updates for new versions already approved by the Protocol Governance or the addition of smart contract modules, optional per market.

  • Risk configurations per asset. Loan-to-Value, Liquidation Threshold, Liquidation Bonus and automatic liquidation parameters.

  • Interest rates model per asset. Adjustment of the curves which determine the relationship between the state of each asset’s reserve and its interest rates.