DeFi Lending

What is DeFi Lending?

Decentralized finance (DeFi) lending offers a way to borrow without the common hurdles found with conventional loans. Instead, you can borrow against crypto collateral, giving you instant access to funds.

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Business in the DeFi lending category is booming, with an estimated $24.62 billion in total value locked in smart contracts.

Techopedia Explains

DeFi lending refers to using smart contracts, computer programs that run on blockchain networks, to borrow against cryptocurrency collateral. In addition to borrowing, most platforms also support lending, allowing depositors to earn a yield.

Traditional lending bases loan eligibility on a number of factors, often including credit scores, income, debt-to-income, and collateral. By contrast, DeFi lending typically only considers collateral.

There’s also no need to ask a bank or lender for a loan. With a few clicks – and enough crypto collateral – you can borrow instantly. This makes DeFi lending permissionless.

Additionally, there’s no need to explain how you will use the borrowed funds or even provide your name. Your crypto wallet address becomes your identity for the purposes of the loan.

How Does DeFi Lending Work?

Crypto loans take different forms, including centralized platforms such as Nexo, or decentralized platforms like Aave or Compound Finance.

DeFi lending uses decentralized platforms, meaning there’s no company or management team making the lending decisions.

Instead, DeFi lending uses smart contracts that work the same for everyone, regardless of income, nationality, or other factors. The DeFi lending protocols themselves are often run by the global community, using crypto tokens to vote on proposals.

  • Lending protocols like Aave use cryptocurrency collateral to back the loan.

Let’s say you have 10 ETH and you don’t want to sell your ETH to raise money. As an alternative, you can deposit the ETH on Aave or a similar platform and then borrow against the ETH you deposited as collateral. On Aave, you’ll also earn interest on your deposit. All deposits go into a pool from which borrowers can take loans.

In this example, you’re not limited to borrowing ETH, however. You can use your ETH as collateral and borrow USDT, for instance, a popular stablecoin cryptocurrency that tracks the value of the US dollar.

  • You’ll pay interest based on the borrowing demand in the pool versus the supply.

DeFi lending protocols like Aave don’t require fixed monthly payments. Repay whenever you’re ready, but be aware that the loan continues to accrue interest, which adds to your loan value. It’s also prudent to watch interest rates, which can increase the cost of borrowing if borrowing demand surges.

Loan-to-value (LTV) plays a vital role in DeFi lending. As LTV increases, meaning the value of the loan relative to the collateral value increases, the loan inches closer to liquidation, which is an automatic sale of your collateral.

Pros and Cons of DeFi Lending

Pros Cons
– DeFi lending makes loans available to anyone with crypto collateral.
– Borrowers can borrow without fixed repayment terms.
Interest rates are often lower compared to personal loans.
– Borrowed funds can be used for any purpose.
– Loans must be repaid in the same cryptocurrency borrowed, possibly adding additional trades and costs.
Volatility can reduce the value of collateral, possibly causing a liquidation.
– Smart contracts used by DeFi platforms may be vulnerable to hacks.

What are DeFi Lending Platforms?

DeFi lending platforms offer a user-friendly front end to complex smart contracts that make lending and borrowing possible. As a technical matter, the contracts are also accessible without the front end by using third-party tools or custom software if you’re handy at coding.

Popular platforms include:

These platforms let you connect a compatible crypto wallet to deposit funds and then borrow was needed. Many look similar, using an easy-to-navigate two-column design highlighting assets supported for deposits and assets available for borrowing.

How Can I Borrow With DeFi?

How to Borrow With DeFi?

To learn how the borrowing process works, let’s use a step-by-step example.

  1. Buy a Cryptocurrency Eligible for Collateral: If you don’t already have some crypto, investigate which types of crypto can be used for collateral. Commonly supported options include ETH, USDT, and USDC. However, many platforms offer a much wider selection of collateral-eligible coins or tokens. You may want to postpone this step until you choose a platform.
  2. Choose a Platform and Network: In this case, let’s use Aave because the protocol supports 10 networks. Which network you choose may depend on how you want to use the funds. For example, if you need to use your borrowed funds on the Abitrum network, you’ll likely want to deposit and borrow on Aave using Arbitrum to save on overall costs and avoid cross-chain bridge fees.
  3. Check Availability: DeFi lending platforms often use supply and borrowing caps. Be sure the protocol has enough capacity for you to deposit and borrow. Usually, you can tell at a glance.
  4. Make Your DepositConnect your crypto wallet to the lending protocol and look for a deposit button. Enter your deposit amount.
  5. Borrow the Funds You Need: Tap the borrow button to take a loan. But remember, market price moves and accrued interest can affect your LTV, so borrowing less is often safer. The borrowed funds are sent to your crypto wallet.

FAQs

Is DeFi lending risky?

What is DeFi private lending?

What is the difference between DeFi staking and lending?

References

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Eric Huffman

Eric Huffman has a diverse background ranging from business management to insurance and personal finance. In recent years, Eric's interest in finance topics and in making personal finance accessible led to a focus on cryptocurrency topics. Eric specializes in crypto, blockchain, and finance guides that make these important topics easier to understand. Publications include Milk Road, Benzinga, CryptoNews.com, Motor Trend, CoverWallet, and others. Always learning, Eric holds several certifications related to crypto and finance, including certificates from the Blockchain Council, Duke University, and SUNY. When he's not writing, you might find Eric teaching karate or exploring the woods.