Borrowing & Lending

DeFi borrowing and lending allow users to access liquidity, earn passive income, and participate in leveraged strategies using blockchain-based protocols. These platforms enable permissionless, transparent financial services, where lending and borrowing occur directly between users through smart contracts.

🔄 How DeFi Lending Works

1. Lenders deposit assets into liquidity pools (e.g., ETH, USDC, DAI) and earn interest from borrowers.
2. Borrowers take loans by depositing collateral (e.g., ETH for borrowing USDC) to secure the loan.
3. Interest rates are determined algorithmically based on supply and demand.
4. If collateral value drops below a required threshold, it may be liquidated to protect lenders.

⚙️ Key Features

✅ Overcollateralized Loans – Most DeFi loans require collateral worth more than the borrowed amount (e.g., borrowing 50% of collateral value).

✅ Algorithmic Interest Rates – Rates fluctuate based on asset demand and liquidity availability.

✅ No Credit Scores – Loans are secured by collateral, eliminating the need for credit checks.

✅ Liquidation Mechanisms – If collateral falls below a threshold, smart contracts automatically liquidate assets to repay the loan.

🏛 Example 1: Lending on Aave

A user deposits USDC into Aave, earning 6% APY as borrowers pay interest. The protocol ensures capital security through overcollateralization and liquidation rules.

🏛 Example 2: Borrowing on Compound

A trader deposits ETH as collateral on Compound to borrow DAI, allowing them to trade or farm yield while keeping their ETH holdings. If ETH’s price drops too much, the loan gets liquidated to protect lenders.

📚 References

1. Coinbase – Crypto borrowing: how to get liquidity without selling your crypto

2. Kraken – Crypto loans: What they are and how they work

⚠️ Controversies & Misconceptions

• “DeFi loans are risk-free” – False. Smart contract vulnerabilities, liquidation risks, and interest rate fluctuations can affect profitability.
• “Borrowers can take unlimited loans” – False. Borrowing limits depend on collateral value and protocol loan-to-value (LTV) ratios.

🚀 Conclusion

DeFi borrowing and lending platforms provide an alternative to traditional banking, enabling users to earn passive income or access liquidity. However, users must understand liquidation risks, interest rate fluctuations, and smart contract security before participating.

Related Terms

• APY (Annual Percentage Yield)

  Annual Percentage Yield (APY) is the real rate of return on an investment, accounting for the effects of compounding interest over time. In DeFi, APY represents the annualized yield from staking, lending, or liquidity providing, assuming interest is regularly reinvested.

• Ethereum 2.0 (Eth2)

  Ethereum 2.0 (Eth2) is a major upgrade to the Ethereum network that introduces Proof-of-Stake (PoS) consensus and scalability improvements to enhance security, efficiency, and transaction throughput.

• Know Your Customer (KYC)

  Know Your Customer (KYC) is a regulatory process that financial institutions and certain other businesses use to verify the identity of their clients. This process ensures that institutions are not inadvertently facilitating money laundering, fraud, or other illicit activities.

• Permissionless

  A permissionless system is one that allows anyone to participate without needing approval or permission from a central authority. This model is fundamental to decentralized networks, enabling broad participation and governance.