DeFi Lending

Learn more about DeFi lending with Bunny Board.

What is DeFi Lending?

DeFi lending is a concept within the Decentralized Finance Applications idea. This concept presents a new kind of lending market where lenders/borrowers can utilize their cryptocurrencies or digital assets and the market is decentralized and autonomous operated by smart contracts on blockchains.

You can simply think about a banking system where it has lenders (who deposit money into the bank) and borrowers (who borrow money from a bank). DeFi lending works with the same concept but all users can use cryptocurrencies and the market is operated by smart contracts, not the bank.

How does it work?

Depositing Funds: Lenders deposit their crypto assets into the lending pool of the DeFi platform. These assets are then made available for borrowing.
Borrowing Funds: Borrowers provide collateral (typically over-collateralized to ensure the lender's security) and can borrow against it, up to a certain percentage of its value.
Interest: Borrowers pay interest on the amount borrowed, and lenders earn a portion of that interest in proportion to their contribution to the lending pool.
Collateral Liquidation: If the value of the borrower's collateral drops below a certain threshold (due to market volatility), the smart contract will automatically liquidate the collateral to repay the loan and protect the lender.
Repaying the Loan: Once the borrower repays the loan plus interest, they regain full access to their collateral.

What are the components of a typical DeFi lending market?

Lending: Users can lend their cryptocurrencies or digital assets in exchange for interest by depositing their assets into the protocol's smart contracts which then act as an escrow, holding the assets until they are repaid.
Borrowing: On the opposite, borrowers can request loans by providing collateral in the form of cryptocurrencies. They lock up a certain amount of collateral in the protocol's smart contract, which acts as security for the loan.
Interest Rates: Unlike the banking system, interest rates were determined by banks or the governance. DeFi lending interest rates were determined by supply and demand within the platform using smart contracts. They can fluctuate based on factors such as the availability of assets for lending and borrowing, market conditions, and the risk associated with different assets.
Smart Contracts: All assets and lending and borrowing activities are governed by smart contracts, which are self-executing contracts with the terms of the agreement directly written into code. These smart contracts were deployed and run on public and open blockchains which is the idea of decentralization. This ensures transparency, security, and automated execution of transactions without the need for intermediaries.
Liquidation: To mitigate the risk of default, lending platforms often have mechanisms in place for liquidating collateral if the value of the collateral falls below a certain threshold. This helps ensure that lenders are compensated for their loans even if borrowers default. These liquidation mechanisms are also operated by smart contracts on blockchains.

Why do we need liquidations?

Liquidation is so important in DeFi lending, it helps to protect lender's assets and prevent lending market bankruptcy.

Let's dive into an example:

Bob is going to borrow some USDT tokens and use his ETH tokens as collateral assets. Alice wants to lend her USDT tokens to Bob but she must make sure that Bob's ETH tokens collateral is bigger than his USDT loan in value. And the lending market must protect Alice's USDT tokens by monitoring Bob's ETH tokens collateral. Whenever the ETH price drops to an unsafe threshold, the lending market must sell all of Bob's ETH tokens for USDT tokens to protect Alice's assets.

What are the types of DeFi lending?

There are so many types and concepts of DeFi lending, every protocol and platform has its concepts and definitions. However, we can defines them into three main categories:

Cross-lending: Cross-lending protocols define all assets as reserves and pool them into protocol into a single liquidity pool. All activities are operated in the form of multiple lending/borrowing assets and cross-collateral assets. In these protocols, users can use any asset for collateral and borrow any asset as well. However, in every protocol, they have different risk management on every kind of asset.
CDP lending: CDP known as Collateralized Debt Position was first introduced by the MakerDao protocol. It is a system created that locks up assets as collaterals in the protocol smart contracts in exchange for stablecoins or debt assets. In Cdp lending, borrowers can lock supported assets as collaterals and borrow only debt assets defined by the protocols. For instance, users can lock up ETH tokens into MakerDAO and borrow only DAI tokens.
Isolated-pools lending: Isolated lending are separate lending pools that support a set of assets that can be used as collateral for loans against each other. This is in contrast to having a single cross-lending pool in which any asset can be borrowed against any other.

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Last updated 3 months ago

What is DeFi Lending?

How does it work?

Depositing Funds: Lenders deposit their crypto assets into the lending pool of the DeFi platform. These assets are then made available for borrowing.

Borrowing Funds: Borrowers provide collateral (typically over-collateralized to ensure the lender's security) and can borrow against it, up to a certain percentage of its value.

Interest: Borrowers pay interest on the amount borrowed, and lenders earn a portion of that interest in proportion to their contribution to the lending pool.

Collateral Liquidation: If the value of the borrower's collateral drops below a certain threshold (due to market volatility), the smart contract will automatically liquidate the collateral to repay the loan and protect the lender.

Repaying the Loan: Once the borrower repays the loan plus interest, they regain full access to their collateral.

What are the components of a typical DeFi lending market?

Lending: Users can lend their cryptocurrencies or digital assets in exchange for interest by depositing their assets into the protocol's smart contracts which then act as an escrow, holding the assets until they are repaid.

Borrowing: On the opposite, borrowers can request loans by providing collateral in the form of cryptocurrencies. They lock up a certain amount of collateral in the protocol's smart contract, which acts as security for the loan.

Interest Rates: Unlike the banking system, interest rates were determined by banks or the governance. DeFi lending interest rates were determined by supply and demand within the platform using smart contracts. They can fluctuate based on factors such as the availability of assets for lending and borrowing, market conditions, and the risk associated with different assets.

Smart Contracts: All assets and lending and borrowing activities are governed by smart contracts, which are self-executing contracts with the terms of the agreement directly written into code. These smart contracts were deployed and run on public and open blockchains which is the idea of decentralization. This ensures transparency, security, and automated execution of transactions without the need for intermediaries.

Liquidation: To mitigate the risk of default, lending platforms often have mechanisms in place for liquidating collateral if the value of the collateral falls below a certain threshold. This helps ensure that lenders are compensated for their loans even if borrowers default. These liquidation mechanisms are also operated by smart contracts on blockchains.

Why do we need liquidations?

Liquidation is so important in DeFi lending, it helps to protect lender's assets and prevent lending market bankruptcy.

Let's dive into an example:

What are the types of DeFi lending?

There are so many types and concepts of DeFi lending, every protocol and platform has its concepts and definitions. However, we can defines them into three main categories:

Cross-lending: Cross-lending protocols define all assets as reserves and pool them into protocol into a single liquidity pool. All activities are operated in the form of multiple lending/borrowing assets and cross-collateral assets. In these protocols, users can use any asset for collateral and borrow any asset as well. However, in every protocol, they have different risk management on every kind of asset.

CDP lending: CDP known as Collateralized Debt Position was first introduced by the MakerDao protocol. It is a system created that locks up assets as collaterals in the protocol smart contracts in exchange for stablecoins or debt assets. In Cdp lending, borrowers can lock supported assets as collaterals and borrow only debt assets defined by the protocols. For instance, users can lock up ETH tokens into MakerDAO and borrow only DAI tokens.

Isolated-pools lending: Isolated lending are separate lending pools that support a set of assets that can be used as collateral for loans against each other. This is in contrast to having a single cross-lending pool in which any asset can be borrowed against any other.