Introduction
Decentralized Finance otherwise known as DeFi is revolutionizing the financial sector by creating a global, open and permissionless financial system. This is achieved through the use of blockchain technology which creates a platform for building decentralized apps that allows anyone from any part of the world to transact in a peer-to-peer manner. At the heart of this revolution are lending and borrowing protocols, which enables users to lend and borrow assets without any intermediary or middleman.
This article explores how Lending and Borrowing works in DeFi, its benefits, key platforms, challenges and future trends.
How Lending and Borrowing works
Lending and Borrowing in DeFi leverages blockchain technology and smart contracts to create a financial system that allows anyone to interact and execute transactions with a decentralized app or protocol that offers L&B services.
Lending
This usually involves a user depositing their crypto assets or tokens into a smart contract on a lending platform. These assets that are deposited by the user are now available for anyone to borrow, in return, the lender can earn an interest which is paid by the borrower.
This is an entirely transparent process with all the transactions on-chain.
Borrowing
To borrow an asset, a user MUST provide a collateral which is often in the form of other crypto assets.
Here’s a typical example:
- User A wants to borrow $ETH from a protocol
- User A has $DAI in his wallet and the protocol accepts the token as collateral
- User A puts down $DAI as a collateral on the protocol and proceeds to borrow $ETH
Note that the collateral that is put down by the borrower has to exceed the value of the loan(asset borrowed). This is a strict mechanism that essentially protects the lender in case of a market downturn. The borrower pays an interest on the loan and if the value of their collateral drops below a certain threshold, it triggers a liquidation which is used to repay back the loan.
All processes of liquidation and repayment are automatic and executed by smart contracts owned by the protocol.
Key Platforms and Protocols
Since the inception of decentralized finance, here have been some platforms which have emerged as the key protocols and leaders in the lending and borrowing space.
Aave is a decentralized non-custodial liquidity market protocol where users can participate as suppliers or borrowers. The suppliers provide liquidity to the market to earn a passive income, while borrowers are able to borrow in an overcollateralized (perpetually) or undercollateralized (one-block liquidity) fashion.
The Aave protocol is one of the biggest DeFi protocols with over $20b of liquidity locked. It is also completely open-sourced which means that anyone with the technical know-how can build a third-party service or application with the protocol.
PS: The Plend Protocol is making use of the Aave contracts as an initial step to build the platform as the Aave contracts have been battle-tested and is one of the most forked for lending protocols.
You can read more about Aave here
Compound is an EVM compatible protocol that enables supplying of crypto assets as collateral to borrow a “base” asset. It allows users to earn interest on their crypto by supplying assets to liquidity pools. Compound’s interest rates are algorithmically adjusted based on supply and demand.
The protocol is also widely used by many projects and open-sourced
Read more about the Compound Protocol here
3. MakerDAO
MakerDAO is a decentralized protocol that is widely known for its stable coin $DAI, which anyone can generate by collateralizing their crypto assets. To put into simple terms, you can get $DAI by locking up your $ETH as a collateral on the platform.
Most DeFi lending and borrowing platforms make use of MakerDAO’s $DAI stable coin for generating yield as its best suited for that.
You can read up more about the platform and how it works in depth here
Benefits of Lending and Borrowing in DeFi
Participating in lending and borrowing opens a whole new door to a revolutionary financial system and offers several advantages over traditional financial systems.
Some benefits include:
- Accessibility
Most DeFi platforms are open to anyone with an internet connection and crypto wallet. This creates a gateway for billions of people all over the globe who are excluded by traditional financial services to participate regardless of their geographic location. Individuals can lend their assets to earn interest or borrow funds by providing cryptocurrency as collateral or even depositing their assets in liquidity pools to earn competitive yields.
2. Transparency
All transactions in DeFi are transparent and can be publicly viewed on the blockchain where it is permanently recorded, reducing the risk of fraud. This transparency also involves users gaining access to real-time data and analytics on lending rates, total value locked (TVL), collateral ratios and more which helps the user make informed decisions based on the current market conditions.
3. Enhanced Security
This also stems from transparency, as the open nature of lending and borrowing protocols allows the community to scrutinize and audit the platform continuously. This particular collective oversight by community members and interested individuals helps identify and mitigate vulnerabilities more than a closed centralized financial system that offers interests in L&B.
Risks and Challenges
While we have opportunities presented to us by Lending and Borrowing protocols in DeFi, there also comes risks which sometimes are overlooked during the protocols audit or even a hack.
Some identifiable risks include the following;
- Smart Contract Vulnerabilities
- Market Volatility
- Regulatory Uncertainties
Future Trends
As the decentralized finance space continues to evolve, so do new technologies, tools and trends with innovative applications.
Let’s evaluate some trends which has been spurring in recent time 👇
⛓️Cross-Chain Lending Solutions
As DeFi expands across multiple markets and blockchains, cross-chain solutions are becoming increasingly vital. These solutions enable the seamless lending and borrowing of crypto assets across different blockchain networks, addressing one of the key limitations of the current ecosystem — fragmentation.
The DeFi ecosystem is currently fragmented, with multiple blockchains operating independently. This fragmentation presents several challenges:
- Limited Asset Utilization: Users can only lend or borrow assets within the same blockchain, limiting the potential for asset utilization and liquidity.
- User Experience: Managing assets across multiple blockchains can be complex and cumbersome for users, requiring multiple wallets and interfaces.
- Liquidity Fragmentation: Liquidity is spread thin across different blockchains, reducing the overall efficiency and effectiveness of lending and borrowing platforms.
Cross-chain lending solutions address these challenges by enabling the interoperability of assets and liquidity across multiple blockchains. These solutions utilize various technologies and mechanisms to facilitate the movement of assets between blockchains which include decentralized bridges, wrapped assets, and interoperability protocols and cross-messaging platforms.
The benefits of cross-chain lending solutions includes:
- Increased Liquidity: By enabling assets to move freely between blockchains, cross-chain solutions aggregate liquidity from multiple sources, enhancing the overall liquidity available for lending and borrowing.
- Enhanced Asset Utilization: Users can leverage their assets across multiple blockchains, maximizing their earning potential and improving capital efficiency.
- Improved User Experience: Cross-chain solutions simplify the user experience by providing seamless access to lending and borrowing opportunities across different blockchains through a unified interface.
- Broader Market Reach: Platforms can tap into the user bases of multiple blockchains, increasing their reach and potential user adoption.
Plend Finance is building a top-tier cross-chain lending protocol which not only enables users to lend their assets across multiple blockchains but also aggregate the liquidity and real-time data from available markets and deliver the best rates to the platform users.
The platform is currently on testnet and everyone is welcome to interact and test out the Plend protocol and explore its features.
👤Improved User Experience and Interface
In order to attract more users, DeFi platforms are now focusing on improving the user experience and interface, making it easier for users to navigate and use these platforms. This can be seen in some lending and borrowing protocols which allocate resources to constantly improve the quality of their UI and provide intuitive landing pages for even newbies to grasp the concept of various terms used in L&B
For example, using the Plend UI, the dashboard displays terms like NET APY, Net worth, Health Factor, Users Deposits & Borrows and Risk details. All these makes it easy for some to get knowledgeable and avoid complicated issues and make informed decisions.
Another future trend worth mentioning is the increased integration of traditional financial systems. This includes the partnership formed by DeFi platforms and traditional finance institutions to bolster the adoption of these protocols and the use of their platforms. For example, a DeFi platform partnering with a fintech or payment platform to introduce on-ramp/off-ramp of assets or stablecoins.
Conclusion
Lending and borrowing in Decentralized Finance (DeFi) represent a transformative shift in the financial sector, providing a global, open, and permissionless financial system powered by blockchain technology. By enabling peer-to-peer transactions without intermediaries, DeFi lending and borrowing protocols offer numerous benefits such as increased accessibility, enhanced transparency, and improved security.
Plend Finance is at the forefront of these innovations, building a top-tier cross-chain lending protocol that aggregates liquidity and real-time data from multiple blockchains to deliver the best rates to users.
Explore the future of DeFi lending and borrowing with Plend and join us in shaping the next generation of decentralized financial services.
Try out the Plend testnet here.
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