What Is DeFi Lending and How Does It Works?

March 26, 2022

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How does Defi Lending Works? The discovery of Blockchain potential has revolutionized the use cases in Financial Sector and gave boosted the overall Fintech ecosystem. From online payments, cryptocurrency trading, lending, and borrowing to storage everything have been strengthened with the inclusion of blockchain technology in the operations.

One such exciting use case of Blockchain technology is DeFi (Decentralized Finance) lending which has found its status quo in decentralized technology. So, does it make you curious to understand how the DeFi lending and borrowing concept works? If yes, let’s delve deeper and understand its algorithms.

What is DeFi Lending?

The framework of DeFi lending works on a decentralized model and P2P network for managing assets, Furthermore, it aims at providing an open-source, Permissionless, transparent, and secure finance service ecosystem. Using the decentralized platform borrowers can directly acquire loans and lenders can also earn interests.

DeFi is emerging as the prevalent contributor for locking crypto assets. As per the study of DeFi-Pulse, the Total Value Locked (TVL) in such protocols witnessed a twenty folds growth from $1 billion to $20.46 billion in just a year. Hence, DeFi lending is a result of a decentralized platform where cryptocurrency loans are offered in a trustworthy manner.

Is DeFi lending better than Traditional Lending?

The execution and performance of DeFi Financing differ significantly from Traditional Financing. However, both the lending model works on the common financial standards. Traditional Financing models operate with the help of intermediaries, who play important role in verifying and processing the loan, On the contrary, DeFi lending facilitates the most straightforward borrowing and lending functions through Crypto wallet which works on Smart Contract.

Alongside the censorship-free environment of the DeFi ensures immutability leading to the creation of better margin trading options. Furthermore, the long–term investors get the opportunity to lend their crypto assets and earn higher interest rates on them which would have been lying idle otherwise.

An added advantage users get with Decentralized Financing is that it enables users to access fiat currency for borrowing purposes by selling on a centralized cryptocurrency exchange and facilitates finally lending through the Decentralized Exchange. Though Traditional Finance has shaped the lending culture for the longest time yet the lack of alternatives created the bigger financing gap with DeFi is expected to bridge upto a good extent.

How does DeFi Lending Work?

The DeFi Financing is a composition of two major aspects – Borrowing and Lending. For both these aspects, some of the processes overlap while the others are distinct. In the entire process, the DeFi lending process acts as the central point through which everything transacts.

  1. The borrower registers with the Platform and gets their wallet activated.
  2. Deposits Digital Assets ( Cryptocurrency and Coins) as a Collateral.
  3. The borrower receives a loan against the Collateral.
  4. After the pre-decided duration, the loan is repaid with the interest.
  5. With the payment of the loan, the Collateral is returned to the Borrower
  6. While the lender deposits fund in the platform as fiat currency and earn the subsequent interest against their lending. All the processes are verified by the smart contracts in the DeFi platform.

Benefits of DeFi Lending to users

The ease of availing DeFi loans is choosing the tech enthusiast and aware users. With DeFi lending protocols the loan processing has improved eventually. So, let’s draw our attention to the precise benefits that DeFi lending can provide its users.

The digitally-enabled lending process allows fast processing of loans with its cloud-based infrastructure. The system proves advantageous in fraud identification, Machine Learning calculations, predicting risks, and implementing profound practices in place. The advanced technology use allows platforms to approve loans with speed via e-contracts. It also takes into account the consistency in credit policies and compliances by Federal, State, and Local authorities relating to the matter.

The Permissionless protocol of DeFi lending allows anybody with the crypto wallet to access the DeFi application for their respective purpose while building transparency which is verified by each user. Furthermore, the advanced lending technique allows secure data coordination and audibility. This leads to the creation of the DeFi marketplace where participants get the chance to receive custody and control of their data.

Popular DeFi Platforms

The emergence of DeFi lending needs has given rise to several platforms that support the idea of decentralized financing. Some of the well-known games in the DeFi industry are:

Platforms Description
MakerThis unique DeFi lending platform only allows the borrowing of DAI tokens which is a type of Stablecoin pegged with US dollars. Thus, the users have to lock assets either in ETH or BAT as debt collateral.
AaveIt is an open-source DeFi lending protocol that works on a non-liquidity protocol to earn interest.  Algorithmically the interest rates are adjusted here based on the demand and supply of the token.
CompoundThis autonomous and application money market is a way to unlock an open financial system where governance and compound native tokens are used to offer DeFi lending. It supports the assets like ETH, WBTC (Wrapped Bitcoins), REP, USDC, DAI, ZRX, etc.

However, there are several platforms in the race yet these three DeFi platforms are widely accepted by users across the world.

Final Words

The high potential of the DeFi lending mechanism makes it possible to reshape the complete financial system with its advanced analytical and intelligent technologies. As a result, trading, financing, investing, borrowing, lending, etc everything gets a fresh kick start with Decentralized Financing. Moreover, it holds high potential to address the opportunities and gaps in the financial ecosystem.

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