DeFi is an innovative field of digital finance that differs from traditional finance in the following ways:
It eliminates intermediaries and allows direct participation in lending, borrowing, trading, and other activities. Despite its technical complexity, DeFi has reached a multi-billion dollar valuation within a decade of its creation.
What is DeFi? DeFi is a cryptocurrency-based financial spectrum based on the following ideology:
It operates on a decentralized, permissionless, and transparent framework, accessible to anyone regardless of physical location. Built on the principles of cryptocurrencies and blockchain technology, DeFi supports various financial applications such as staking, lending, borrowing, and trading, And more.
DeFi lending is the practice of peer-to-peer lending of crypto assets. It works in a trusted and automated way. Users can borrow or access funds by or other assets deposited as collateral. Users can use the borrowed funds however they like. Lending in DeFi varies depending on factors such as the type of collateral, the utility of the asset, and market trends. Certain protocols allow under-collateralized loans that exceed the collateral valuation, while others offer over-collateralized loans to ensure safety. Borrowers are also subject to pre-defined interest rates, usually measured in APY and APR. Notably, the accessibility of DeFi transcends geographical borders, allowing people to participate in lending and borrowing worldwide without relying on banks or fiat currencies, creating a decentralized financial marketplace. In theory, DeFi lending works on the principles of trustlessness, peer-to-peer, and an open network where transactions are carried out without intermediaries.
Elements of DeFi Lending All the elements listed below work together to form an ecosystem that facilitates lending and borrowing in decentralized finance.
Liquidity: Liquidity is the most important element in decentralized
finance. This refers to the current availability of assets that can be used immediately. In the DeFi space, liquidity plays a key role as it enables the creation and running of various applications.
Smart Contracts: Blockchain-based smart contracts are the digital strategies that make liquidity in the DeFi ecosystem work. These contracts contain the various methods and instructions that allow crypto assets to be lent, borrowed, and spent.
Lending Pools: DeFi lending pools allow users to provide liquidity through smart contracts. Borrowers can access funds from these pools by paying fees, which may be fixed or dynamic depending on the asset’s popularity. Unlike traditional loans, DeFi loans do not require borrowers to submit proof of income or privacy-related documents, as they operate without regulatory compliance burdens.
On the other hand, DeFi loans are completely straightforward and do not require any information from the borrower. The inherited properties of blockchain, such as transparency, immutability, and high-end security, make DeFi loans much more secure than traditional loans.
DeFi loans and borrowing work through crypto loans offered by various lending platforms. Types of loans in DeFi include:
1 – Overcollateralized loans:
In DeFi lending, overcollateralized loans allow users to borrow up to 80% of their deposited assets. For example, if you deposit $1,000 worth of ETH, you can borrow up to $800. These loans use efficient collateral as collateral and allow credit protocols to liquidate positions in case of default.
2 – Undercollateralized loans:
Conversely, undercollateralized loans in DeFi offer users the opportunity to raise even larger amounts of funds. The amount borrowed is often based on the borrower’s creditworthiness in the cryptocurrency space. These loans are usually offered by lending platforms that are confident in the borrower’s ability to repay.
3 – Flash Loans:
A unique feature of some DeFi lending platforms, flash loans are unsecured cryptocurrency loans that are settled and repaid within a single blockchain transaction. Lending protocols will only execute the loan if an interest-bearing repayment is made in the same transaction, making it a groundbreaking financial product in the DeFi environment.
Advantages of DeFi Lending:
DeFi lending is revolutionizing decentralized finance, offering participants a range of innovative benefits. This includes:
1 – Permissionless Access: DeFi lending has no barriers to entry. Borrowers and lenders can enter without permission, making it accessible to anyone without geographical restrictions.
2 – Guaranteed Execution:
DeFi lending is based on smart contracts that ensure flawless execution of transactions and precise numerical results. Deviations of even a single decimal point can halt a transaction or produce unintended consequences.
3- Programming flexibility:
Users can experiment with DeFi lending through smart contract functionality, allowing for complex terms and transactions within a single agreement.
4 – Peer-to-peer dynamics:
DeFi lending removes the need for intermediaries, allowing for direct peer-to-peer transactions. Borrowers can access funds from DeFi lending pools without outside interference.
5 – Abundant liquidity:
Decentralized finance offers extensive liquidity that is often underutilized. The DeFi lending industry is worth billions of dollars, so liquidity needs are well met. Users can borrow large amounts of funds if collateral requirements are met. Popular DeFi Lending Platforms
DeFi lending platforms or protocols are where decentralized lending and borrowing is accessible. These platforms are deployed on a blockchain network as a series of smart contracts.
Below are some of the popular DeFi lending platforms:
– Aave: A pioneer in DeFi, Aave is one of the early decentralized lending and borrowing protocols. It was previously known as ETTHland when it launched in 2017. Aave is currently the most popular DeFi lending protocol with over $10 billion in TVL and is deployed across 8 different blockchain networks including Ethereum, Polygon, and more.
– Compound: Compound is also a leading DeFi protocol that allows for the lending and borrowing of various crypto assets. The company operates primarily on Ethereum and has a TVL of around $2.4 billion despite crypto market fluctuations. Borrowers can back their over-collateralized MakerDAO DAI loans with collateral.
Venus Protocol:
Venus is the most popular DeFi lending protocol available online. Based on BNB Chain. Created by the team behind BUSD, BNB, USDT and BTCB on BNBchain. Launched on cryptocurrency exchange Binance.
My conclusion, Decentralized finance (DeFi) is growing rapidly and could soon reach hundreds of billions in total value locked (TVL) as cryptocurrencies continue to rise in value. DeFi lending and financing is the most exciting part of this new financial world.
DeFi lending is still new, but it is growing quickly and has plenty of room for further growth. It has the potential to completely transform finance and create a secure and powerful financial system that is not based on trust.
MakerDAO: While Aave and Compound focus on different crypto assets, MakerDAO works by trading its native stable coin, DAI, for other assets like lending ETH. The value of DAI is pegged to the USD and is used as a hedge.
By going through our article on DeFi Lending Explained, you’ll gain a comprehensive understanding of the theoretical framework of DeFi lending and this article on Deep Dive Into the DeFi Protocol For Liquidity, you get the practical application of AAVe as a leading platform.