DeFi lending platforms are aimed at offering crypto loans in a trustless manner, i.e., without third parties. For lending purposes, these platforms allow users to enlist their crypto coins on the platform. In this regard, a borrower can directly take a loan through the decentralized platform known as P2P lending. moreover, with the lending protocol, lenders can earn interests. Among all of the decentralized applications (DApps), Defi has the highest lending growth rate and offers the most prevalent way for locking crypto assets.
The mechanisms of DeFi lending are fundamentally very similar to traditional lending:
- One person lends assets, doing so in exchange for interest payments (and in some cases, additional rewards)
- Another person borrows assets, paying interest payments for the right to instant funding
However, deFi lending is different from traditional lending in that it allows users to become lenders or borrowers in a completely decentralized and seamless way, while enjoying full custody over their funds. It is based on smart contracts, meaning that there is self-executing security. This is also why crypto lending and borrowing based on DeFi is available to everyone with no need to reveal or share your personal information or trust someone else to store your money.
Defi lending offers complete transparency with easier access to assets for every money transfer process without intermediaries.
How DeFi lending works?
If you take out a loan from the bank, you have to offer some sort of collateral associated with the loan. For instance, if you are taking out a loan to buy a car, the car itself is the collateral. If you do not pay back the loan, the bank seizes your car.
Then, instead of having a physical property like a car or a house as collateral, it’s generally cryptocurrency that’s pledged. The borrower has to offer something more valuable, or at least equal to, the loan amount.
Often people borrow stablecoins such as DAI or Tether (as stablecoins, they’re effective mediums of exchange) and use their more valuable assets (stores of value, such as bitcoin, Ethereum or others) as collateral so that they don’t have to sell and run the risk of buying back at a higher price. It’s safer for someone wishing to keep their cryptocurrencies and get additional liquidity.
With crypto assets in a wallet, there is the possibility of earning interest. The underlying value may increase or decrease, but you’re not earning anything for holding that particular cryptocurrency. This is where DeFi loans come in.
Imagine you can lend your crypto to someone else and earn interest on the loan. That’s how banks currently work, but it’s a service that is accessible to few individuals. Thanks to blockchain technology, anyone can become a lender in the world of DeFi.
There are a wide variety of ways to generate interest by lending your crypto assets to others, but the main way is through lending pools. These are essentially the loan offices of a traditional bank.
When a borrower wants to take out a loan, they need to offer something more valuable than the amount of the loan. That means they need to deposit via a smart contract an amount of currency that is at least of equal value to the amount they’d like to take out. The collateral, however, can be in a wide variety of currencies. therefore, if you want to borrow one bitcoin, you have to deposit the current price for one bitcoin in DAI.
A few months later, you’re finished with the loan and need to pay back your bitcoin + 10 per cent and then you receive your DAI back. The borrower is happy because they got their original DAI back without selling them and the pool is happy because they can now distribute the 10 percent in bitcoin across the pool of investors.
In short, deFi lending benefits both lenders and borrowers. Defi lending has great opportunities to revolutionize the global financial market.