What is DeFi Lending?

June 07, 2024

Overview

DeFi lending allows users to lend or borrow cryptocurrencies directly via platforms like Aave and Compound, using smart contracts for secure, automated transactions without intermediaries.

4 min. read

4 min. read

4 min. read

In the previous article, we talked about DeFi trading, but let us explore another option within the decentralized finance industry: DeFi lending.

DeFi lending is similar to the traditional lending service offered by banks, where users have the option to lend their cryptocurrencies to others and earn interest, or to borrow cryptocurrencies by providing collateral. Unlike traditional lending, DeFi lending operates without third parties, banks, or financial institutions, relying instead on smart contracts on blockchain networks to automate and secure the process.

The DeFi lending process is simple. Users lock their crypto assets on a DeFi platform as collateral. Borrowers can then directly take out loans from the platform's lending pool in a peer-to-peer (P2P) manner without any intermediaries involved. 

Some Examples of DeFi Lending Protocols

Popular examples of decentralized platforms that offer DeFi lending are Aave and Compound.

Aave is a decentralized platform that was deployed on the Ethereum network in January 2020. The platform allows users to either lend or borrow cryptocurrencies. Those who lend their crypto assets to the platform's liquidity pools earn passive income through interest. Users can also do over-collateralized borrowing on AAVE. For example, an investor always needs to have a higher dollar value of his deposit compared to the amount he is borrowing, so that if the value of the deposit drops too much, the loan can be liquidated to repay lenders, ensuring their funds are protected from volatile collateral risk.

Compound is a decentralized finance protocol that is also built on the Ethereum blockchain, serving as a decentralized money market. It has its own ERC-20 token called COMP. Compound functions as a decentralized application where users can either lend their cryptocurrencies to earn interest or borrow cryptocurrencies by providing collateral. To incentivize participation from both lenders and borrowers, Compound rewards users with COMP tokens whenever they use or interact with the protocol, such as borrowing, withdrawing, or repaying loans. This reward system promotes active usage and helps maintain a healthy lending market.

Disclaimer: The information provided in this research paper is for educational and informational purposes only. It does not constitute financial advice, investment guidance, or any solicitation to buy or sell financial instruments. The views expressed herein are those of the authors and do not necessarily reflect the opinions of Kollectiv.

2024