While the concept of financial ‘lending’ has been around for eons, DeFi lending is a recent innovation and works through the DeFi lending platform or DeFi protocols that offer cryptocurrency lending reliably.
Unlike the ordinary financial ecosystem, the DeFi space operates without any central authority third party. DeFi Loan allows holders to stake their coins on DeFi lending platforms for lending purposes and earn interest without intermediaries.
DeFi or Decentralized Finance is an ecosystem of financial applications built on blockchain technology. The DeFi ecosystem started on the Ethereum network and is built on self-executing smart contracts that don’t require a third-party middleman. It relies on a peer-to-peer network to establish decentralized applications, assets and protocols that provide a range of financial services and functionality similar to those offered by conventional banks and financial intermediaries.
Read on to take a closer look at how DeFi loans work and how they pushed finance in a new direction.
How the DeFi loan works
DeFi Loan allows traders to offer their cryptocurrencies for lending on the platform without a central authority having access to their data. It allows seamless and easy access to assets from anywhere in the world for every financial transaction without third party interference.
DeFi has the maximum loan growth rate and provides loan benefits to lenders and borrowers. It also offers margin trading opportunities, allowing long-term investors to lend their assets while earning higher interest rates.
These Defi protocols allow users to borrow loans at reduced rates. Users can exchange fiat currency for cryptocurrency on centralized exchanges and then lend it out on a decentralized exchange.
Challenge lending platforms
When using DeFi protocols like Aave, users interested in becoming “lenders” have to transfer their funds into what is called a “money market” using a smart contract, after which the tokens become. available to borrow from other users.
Crypto financing allows investors to borrow money or crypto assets by mortgaging their crypto holdings as collateral. The lender retains ownership of the assets when using the crypto loan. However, the cryptography provided as collateral cannot be moved during the loan period.
The process is relatively straightforward and is described below:
- Users lend cryptocurrency, usually stablecoins, to a lending platform to earn interest without paperwork.
- Contact is made with the loan platform, and a loan is requested by a borrower.
- The borrower guarantees the cryptocurrency as insurance for the loan. The loan is then accepted and the crypto platform attaches the collateral. The borrower must repay the full amount before taking back the collateral fund.
- To maintain the value of collateral relative to the value of loans, the platform can liquidate users’ loan into stablecoins if their collateral falls below a particular range.
Below are some of the most popular DeFi lending platforms:
Launched in 2020, Aave is an open-source Ethereum-based non-custodial DeFi lending protocol that allows its users to borrow assets while simultaneously earning interest on the assets they have to donate to the protocol. The DeFi protocol allows lenders to accumulate assets in a pool, and an equivalent amount of tokens are received in return.
Algorithmically, Aave adjusts interest rates on cryptoassets based on the demand and supply of the protocol. The interest rate you earn from fund deposits can balance the interest rate users earn by borrowing.
With a total value of $ 18.44 billion and several third-party tests and audits, Aave is considered one of the most secure DeFi protocols, achieving a security score of 95.
Maker is a unique Ethereum-based DeFi lending platform that only issues the DAI token, a stablecoin pegged at $ 1. Maker has a secondary token, MKR. Token holders can vote on governance matters, such as changing stability fees and alternative risk settings.
Maker is open to anyone who creates a safe to deposit collateral such as USDC, ETC or other assets and replicate DAI against collateral.
With its total value of $ 15.74 billion and a security score of 85, Maker is one of the most secure platforms.
Compound is an Ethereum-based, stand-alone algorithmic DeFi lending application that uses a money market approach to the cryptocurrency world. It allows anyone to deposit assets into community cash pools and start trading and collecting interest with no fixed term for a loan.
Compound has a total value of $ 15.74 billion and is considered a secure platform with a security rating of 95.
Alchemix is a loan-based Ethereum DeFi platform that uses a new method in which loans are paid off automatically over time. In exchange for the DAI deposit in a smart contract, a token is given to the user, representing the potential future return of the deposit.
You can access all of these DeFi platforms through a CoinStats Wallet, your gateway to DeFi, allowing you to sell, trade, buy, lend, earn and track all of your digital assets from one place.
DeFi loan rate
The most important advantage of DeFi loans over traditional financial loans is that it allows its users to earn high interest rates, with income ranging between 5% and 15% APY (Annual Percentage Return).
Earn protocol fees
DeFi protocols charge a modest fee for activities such as lending, swapping, and borrowing assets. Several DeFi projects allocate a portion of the fees they earn to other users in exchange for providing cash.
CoinStats data shows interest rates and fees on different protocols. Today, Aave, Compound, and Uniswap are among the highest earners based on Ethereum.
Gas fees or transaction fees are fees collected by developers to process transactions on the Ethereum blockchain, where the majority of DeFi transactions occur.
In June 2020, the total gas fees needed to complete a transaction on Ethereum were equal to $ 0.45, while in September they saw an increase of 2,686%, bringing the new fee to 12.54. $.
In the last quadrant of the year, there was a drop in fees due to the downturn in activity, but on January 4, 2021, $ 17.56 was recorded as the average gasoline charge per transaction, the price highest recorded so far.
The Ethereum yellow book requires each trade to attract a minimum of 21,000 gases, which most platforms then adopt as their default limit. A user must define a gas “limit” and a “used” gas. The interrelation of these two will regulate the price – the higher your gas limit, the faster your transactions will be processed.
DeFi loan risks
It’s fair to assume that DeFi loans offer one of the most reliable and attractive approaches to earning passive income, with interest rates significantly higher than those of traditional financial institutions. However, as with any financial institution, several risks are involved.
Here are the three most important risks that everyone should know before lending crypto assets:
You risk a “temporary loss” when you invest your assets in a pool of cash.
An impermanent loss occurs when the assets that an investor locks in a pool of cash change in price after being deposited. This creates a loss instead of just holding assets in a crypto wallet by the liquidity provider.
The risk of impairment is highly dependent on the automated market maker system used by popular liquidity pools. DeFi pools must maintain an asset ratio of two tokens. For example, an ETH / LINK pool may have a fixed ratio of 1:50 respectively, so anyone wishing to offer liquidity into the pool will need to deposit both Ether and Link in the same ratio.
Flash loans are a new generation of loans that do not require collateral. Flash loans use smart contracts to mitigate the risk associated with unsecured loans.
However, borrowers are required to repay the entire borrowed loan in the same transaction, usually within seconds. The transaction is canceled if the borrower does not repay the loan.
DeFi Rug-pulls is a new kind of exit scam in decentralized finance.
DeFi platforms don’t have regulations like traditional financial systems, and users’ trust in the platforms they choose to trade their assets on is typically violated by Rug-pulls.
A new cryptocurrency is created by the developers and paired with a leading cryptocurrency like Ether, and then a liquidity pool is put in place. People are encouraged to deposit their assets into the pool with promises of high interest returns. After intensive marketing of the newly created token, the pool earns a substantial amount of the main cryptocurrency.
The backdoors that are intentionally encoded into the token’s smart contract are then used to mint millions of new coins and then sell the popular cryptocurrency.
This act drains the best cryptocurrency from the pool, leaving millions of worthless coins and the developers vanishing without a trace. A famous example of Rug-pull risks is when in 2020 SushiSwap founder Chief Nomi liquidated his SUSHI tokens after collecting collateral worth over $ 1 billion.
How to Avoid DeFi Loan Threats
Despite the increase in financial scams, there are several steps you can take to investigate the risks before investing in a lending platform.
We have summarized them for you:
Step 1: Check team integrity on other projects.
Step 2: Carefully read the project white paper.
Step 3: Check if a third party has audited the project code.
Step 4: Be aware of red flags, like unrealistic interest rates, excessive promotions, and marketing strategies.
DeFi Lending is a truly captivating technology with the ability to reshape the global financial system. It attempts to decentralize the foundations of traditional financial services such as trade, investments, lending, borrowing and insurance.
As the first global financial system shaped by its very people, decentralized financial lending has created new opportunities for the financial world with giant strides in financial possibilities.