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What Is DeFi Lending and Borrowing | All You Need to Know

DeFi Lending and Borrowing Defi 101

This post talks about DeFi lending and borrowing and its related activities within the entire DeFi space. In other words, this article also explains how the flow of funds or money is considered a vital thing particularly in the realm of crypto finance and the decentralized finance (DeFi) world.

The activity of DeFi lending and borrowing plays a major role in the digital finance economy. It holds an important aspect when it comes to providing monetary assets — Being fiat-based or cryptocurrency, it keeps people going anytime in the phase of a steady income stream.

With DeFi lending and borrowing, there are more things you can practically do. You just have to know the basics and how it really works.

What Is DeFi Lending and Borrowing?

Timely, the concept of DeFi lending and borrowing has been around for many decades which now forms a huge aspect of all digital financial systems. More especially, in the dominant fractional banking setup. However, the brain behind lending and borrowing using DeFi is very simple and straightforward.

In the DeFi lending space, lenders give funds to borrowers. More especially, lenders usually do this with a mindset of receiving a fixed interest rate based on the size of the fund given. Specifically, DeFi lending and borrowing projects mostly occur between an independent entity or a peer-to-peer (P2P) lender at a specific time.

Also, DeFi lending and borrowing operations can be done in several other ways. To mention, the activities can be promoted successfully through a centralized finance institution. Moreover, you can also engage in DeFi lending and borrowing activities via a decentralized finance protocol such as Aave, Maker, and many more.

In line with how centralized finance works, the CeFi operation is described in the same way as that of how most of the traditional banks lend money to their clients. More so, the same as how country banks use custody of customers’ deposited assets to loan other third-party parties, DeFi lending and borrowing principles also follow the same way.

Also, expanding further on our DeFi lending and borrowing tutorial, keep in mind that DeFi protocols enable users to fully become lenders or borrowers automatically mostly in a decentralized manner. In this case, the decentralized way of the lending activities makes them acquire full control over their funds at all times without any extra difficulties.

Moreover, the presence of smart contracts generally brings all these possibilities into the realm of DeFi lending and borrowing through blockchain solutions like Ethereum. Without facing any challenges, DeFi protocols are open-source. This means that in contrast to CeFi, all DeFi platforms are accessible by all ages.

Prior, as users get access free on the DeFi platforms, they are also entitled to other privileges that guide them to not share their data with a central authority.

How DeFi Lending and Borrowing Works?

This section of our DeFi lending and borrowing article discusses everything you need to know about how you can lend and borrow money within the DeFi space.

To begin lending and borrowing in decentralized finance, people directly send the token they want to lend into a “money market”. Therefore, individuals usually do this through smart contract technology.

At this point, the smart contract in its own ways issues interests, particularly in the platforms’ native token. The size of the interest usually comes based on the amount of money that was lent into the “money market.”

Individuals who plan to lend money using DeFi protocols like Aave and Maker are all obliged to supply their own tokens to the “money maker.” In fact, this is an obligatory and must-do thing.

Moreover, this is done individually by sending your digital asset into the smart contract which in turn serves as an automated digital intermediary. Right after doing this, the coin or the token on the DeFi protocol openly becomes available for borrowing.

It is important to note and keep in mind that any tokens prepared for borrowing or lending are always minted in the interest of the DeFi platform’s native token. For instance, Aave interest tokens are called aTokens while Dai also functions as Maker interest tokens.

Also, note that loans that are always given out through any DeFi protocol’s native tokens come as over-collateralized. This eventually means that the users interested in borrowing the funds need to provide a guarantee. Interestingly, the guarantee provided is always in crypto that is even worth compared to the loan itself.

Comparing this digital borrowing and lending technique to the traditional one where a person has to sell their property first before he or she can redeem the loan, it only makes sense that the DeFi borrowing and lending strategy seems quite easy and simple.

Moreover, borrowers are also entitled in the sense that they can use their borrowed funds under the DeFi protocol to increase their leverage mainly on certain trading positions.

Limit of Money One Can Borrow in DeFi Lending

Yes, there are limits to how much money a user can borrow in DeFi lending and borrowing precisely. In line with this, one cannot just wake up and begin to borrow money with no limitation. Also, two main factors mainly govern this headway.

Before borrowing, get to know whether your desired DeFi platform has enough liquidy. Additionally, it is important to know the “collateral cofactor” of a borrower-supplied supply token perhaps, on the DeFi lending protocol. These two factors are must-know things that everyone needs to review in the first place before beginning your borrowing journey in DeFi.

For instance, Ether and Dai lending provides collateral of not less than 75% on the Compound platform. However, this means that borrowers can take a loan up to 75% following with their supplied Dai and ETH.

Mechanics of How Interest Returns Are Shared in DeFi

By using a DeFi-like app, one can choose their desired coin or tokens that they are interested to lend and also a preferred smart contract. Before this, you can also send the interest amount directly to the associated wallet all by the DeFi app.

To successfully know the lender’s interest and how much borrowers need to pay, this can be directly calculated using the ratio of the supplied and borrowed tokens within a specific market.

Also, take note that borrowers’ annual percentage yield (APY) is usually higher than the supply APY. On the other hand, you can also determine interest APY per Ethereum block.

Risks Associated With DeFi Lending and Borrowing

In everything, there is a risk involved. Even this includes DeFi lending and borrowing. All you have to do is to take a serious look at the possible dangers associated and act accordingly. By doing this, you can successfully bridge any gap.

Decentralized finance protocols have risks such as third-party smart contract tampering. More so, the risk of borrowing APYs is also one of the associated dangers. Despite all the downsides, DeFi lending and borrowing activities have no practical dangers when compared to centralized finance. Indeed, this is particularly in comparison with CEX protocols.

In DeFi lending and borrowing, some of the smart contract risks include some of the threats of APYs and how it changes in a short possible time.

Conclusion

To cut a long story short, we at CoinQuora strongly believe that by reading this “what is DeFi lending and borrowing” article, you now know what it is. Furthermore, with no hesitation, prioritize reading over again if you’re not fully content after reading our “what is DeFi lending and borrowing” post. 

Karikari Daniel is a writer who follows the crypto industry closely. He loves fish stew and Real Madrid. He believes in cryptocurrency’s potential to transform the money landscape in his native country Ghana.