DeFi Lending

Defi lending platforms aim to offer crypto loans in a trustless manner, i.e., without intermediaries and allow users to enlist their crypto coins on the platform for lending purposes and the lending protocol allows the lender to earn interests.

Defi Lending vs. Traditional Lending

The underlying technology for defi lending is Blockchain; Defi utilizes all its unique features and performs exceptionally well compared to traditional lending. Defi lending offers complete transparency with easier access to assets for every money transfer process without involving any third-party. It provides the most straightforward borrowing process; the borrower needs to create an account on the Defi platform, have a crypto wallet and open Smart contracts. Defi offers a censorship-free environment, meaning there is no preferential treatment while ensuring immutability. Defi lending benefits both lenders and borrowers. It offers margin trading options, allows long-term investors to lend assets and earn higher interest rates. It will also enable users to access fiat currency credit to borrow loans at lower rates than decentralized exchanges. Moreover, the users can sell it on a centralized exchange for a cryptocurrency and then finally lend it to decentralized exchanges.

How do Defi loans work?

The underlying value of crypto assets may increase or decrease, but sitting idle in wallets doesn’t accrue any interest. Just holding a particular cryptocurrency won’t make any earning. It is the situation where Defi loans come into the picture. Defi loans enable users to lend their crypto to someone else and earn interest on the loan. Banks always have been utilizing this service to the fullest. Now, in the world of Defi, anyone can become a lender. A lender can loan their assets to others and will be able to generate interests on that loan. This process can be done through lending pools, the loan offices of traditional banks.

Users can pool their assets and distribute them to borrowers using smart contracts. There are various ways to distribute interests to investors; hence it is recommended and worth investing some time to research to identify your interest type. The same goes for borrowers, as each pool will have a different approach on how to borrow.

While taking a loan from a bank, collateral is required that is associated with that loan. To get a loan, the borrower needs to offer something more valuable than the loan amount. Smart contracts are used to deposit this amount of currency of at least equal value to the loan amount. Collaterals are available in wide varieties; any crypto token can be used to exchange borrowed cryptocurrency. For example, if a user needs to borrow one bitcoin, he’d need to deposit the price of one bitcoin in DAI.

Furthermore, the prices of Bitcoins keep swinging wildly. A case may arise when the cost of collateral drops below the price of the loan. Now, here the question arises, How to deal with this situation? An example could explain it better. Let’s say a user wants to borrow 100 DAI. MakerDAO requires borrowers to collateralize their loans at a minimum of 150% of the loan value. This straight away means that the borrower needs to collateralize the loan with $150 in ETH. And when the value of collateral reduces below $150 ETH, it becomes subject to liquidation penalty.

What are the benefits that Defi Lending provides to its users?

• Improved loan origination speed

Digitally-enabled lending processes have the most significant advantage of fast processing speed. Defi lending platforms are backed by cloud-based services, analytics for fraud identification and detection and machine learning calculations for optimum loan terms and risk factors. All these technologies eventually help to speed up the process. As soon as the loan is approved, lenders send offers via e-contracts.

• Greater consistency in lending decisions

Rules describing credit policies guarantee consistency in lending decisions. Variations in evaluating applicant attributes and structuring deals by underwriters are eliminated.

• Compliance with Federal, State and Local regulations

Decision rules provide a record of who, when and where the rules were used and which rules were in effect. It plays the role of evidence and ensures that the lender complies with federal, state and local regulations.

• Analytics for process improvement and portfolio profitability

Analytics can help lenders and borrowers get the most out of the digital lending process. Monitoring loan applications over a particular duration (a week, month or year) can help lenders anticipate and allocate proper resources to accommodate seasonal demands. Analytics also provides insights into demographics, loan sources, credit tiers, etc. The portfolio can be improved by determining how borrower characteristics and credit policies affect loan performance.

• Permissionless

Defi lending allows open, permissionless access, meaning anyone with a crypto wallet can access Defi applications built on Blockchain, regardless of their geographical location and without any minimum amount of funds required.

• Transparency

The public Blockchain broadcasts every transaction on the network and is verified by every user on the network. This transparency level around transactions allows for rich data analysis and ensures verified access to every user on the network.

• Immutability

Blockchain’s decentralized architecture ensures tamper-proof data co-ordination and increases security and auditability.

• Programmability

Smart contracts are highly programmable, automate execution and enable the development of new digital assets and financial instruments.

• Interoperability

The use of an interconnected software stack ensures that Defi protocols and applications integrate and complement one another.

• Self-custody

The use of Web3 wallets (like Metamask) ensures that Defi market participants keep strong custody of their assets and control their data.

Conclusion

Defi lending has a high potential to reshape the entire financial system. It attempts to decentralize the core traditional finance services. Defi lending being involved with the intriguing technology truly has vast opportunities to revolutionize the global financial landscape.