DeFi Lending and Borrowing: Rates, Collateral and Liquidation

DeFi lending lets users supply assets to a protocol or borrow under its collateral rules. The mechanics differ between lending markets and systems that issue collateral-backed stablecoins.

In this blog piece, we’ll take a look at the world of DeFi lending and borrowing, exploring how it works, the benefits it offers, and the considerations to keep in mind when participating in these decentralized protocols.

How DeFi Lending & Borrowing Works

Aave and Compound provide lending markets. Sky, formerly Maker, also has a history of collateral-backed stablecoin issuance. These models differ from proof-of-stake validation: staking is not simply lending coins to a blockchain.

Suppliers can earn variable interest, while borrowers generally provide collateral. Utilization, collateral prices, liquidation thresholds and available liquidity determine how a position behaves. The yield is not directly comparable to a protected bank deposit.

The beauty of DeFi lending and borrowing lies in its permissionless and transparent nature. Anyone with a cryptocurrency wallet can participate, and the terms of the loan, including interest rates and collateral requirements, are clearly defined and visible to all users on the blockchain.

The interplay between lending and borrowing in DeFi creates a self-sustaining financial ecosystem. Lenders provide the liquidity that borrowers need, earning interest in the process, while borrowers gain access to funds by leveraging their existing assets. This dynamic contributes to the overall liquidity and efficiency of the cryptocurrency market.

Benefits of DeFi Lending & Borrowing

Increased Accessibility: DeFi platforms are open to anyone with an internet connection and a cryptocurrency wallet, making lending and borrowing accessible to a wider audience, including those who may be underserved by traditional financial institutions.

Higher Interest Rates: Lenders can earn significantly higher interest rates on their deposits compared to traditional savings accounts, as DeFi platforms often offer more competitive rates due to the absence of intermediaries.

Flexibility & Control: DeFi lending and borrowing allow users to have more control over their financial decisions, as they can choose when to lend, borrow, or repay their loans without relying on the approval of a centralized authority.

Transparency & Auditability: All transactions and loan terms are recorded on the blockchain, providing users with full transparency and the ability to audit the system’s operations.

Overcollateralization: To mitigate the risk of default, DeFi platforms typically require borrowers to deposit more in collateral value than they borrow. This is a critical difference from traditional finance, where loans may be unsecured or based on creditworthiness.

Instant Access to Funds: Borrowers can gain immediate access to funds without going through lengthy approval processes.

No Credit Scores: For borrowers, their ability to borrow is based on how much collateral they can offer against their loan. This means that there is zero need for punitive credit score systems.

Flexible Repayments: Many DeFi platforms offer flexible repayment terms, allowing borrowers to repay at any time before the loan matures without facing early repayment fees.

Risks & Considerations

While DeFi lending and borrowing offer numerous benefits, it’s essential to understand the associated risks and considerations:

Smart Contract Vulnerabilities: DeFi protocols rely on complex smart contracts, which can be vulnerable to bugs or exploits that could lead to the loss of funds.

Liquidity Risk: DeFi lending and borrowing platforms depend on sufficient liquidity in the underlying asset pools. Sudden changes in market conditions could impact the availability of liquidity and the ability to complete transactions.

Price Volatility: The value of cryptocurrencies and other digital assets used as collateral can be highly volatile, which could affect the loan-to-value ratio and lead to liquidations.

How To Participate/Explore

Connect through a verified application on a network supported by both the service and wallet. A connection protocol does not authenticate the provider or establish that the position is suitable.

DeFiPrime provide a great list of DeFi lenders — it’s worth taking a look. Check out their DeFi Lending & DeFi Borrowing providers. Simply look out for the ‘connect wallet’ options on any of the listed sites.

Check Unitywallet’s current WalletConnect options for supported networks and request types. Support for a network does not imply compatibility with every lending app on it.

Conclusion

Before supplying or borrowing, understand the asset, rate model, withdrawal conditions and liquidation rules. Control of a wallet key does not remove the risks of funds committed to a contract.