DeFi lending
Also called: crypto lending protocol · money market · decentralized lending
Definition
DeFi lending is borrowing and lending crypto through smart contracts, where lenders earn interest from a shared pool and borrowers must lock more collateral than they borrow.
This entry is shown in English.
How DeFi lending works
On protocols such as Aave, Compound or Morpho, lenders deposit tokens into a pool and earn a variable interest rate that rises when more of the pool is borrowed. Borrowers deposit collateral, such as ETH, and can borrow other assets up to a loan-to-value limit set for that collateral.
Loans are overcollateralized because there is no credit check. If the collateral value falls and your health factor drops below 1, part of your collateral can be sold to liquidators at a discount to repay the debt. Prices come from oracles, so a sharp price move is enough to trigger liquidation.
Risks for lenders include smart contract bugs, bad debt if liquidations fail during crashes, and periods when the pool is fully borrowed and withdrawals must wait.
Example
Suppose you deposit 2 ETH at 3,000 USDC each, worth 6,000 USDC, with a liquidation threshold of 80 percent, an illustrative setting. You borrow 3,000 USDC. Your health factor is 6,000 times 0.8 divided by 3,000, which is 1.6. If ETH falls to 1,875 USDC, your collateral is worth 3,750 USDC and the health factor drops to 1.0. Below that, liquidators can repay part of your loan and take ETH plus a bonus.
Common mistakes
- Borrowing close to the maximum and leaving no buffer for price drops.
- Not watching the health factor during volatile markets.
- Assuming lending interest is fixed when most DeFi rates change every block.
Learn and practise
FAQ
Why do DeFi loans need more collateral than the loan?
There is no identity or credit check, so the protocol protects lenders by requiring collateral worth more than the loan and liquidating it if its value falls too far.
Where does DeFi lending interest come from?
From borrowers who pay interest to use the pool's tokens, sometimes topped up by reward tokens.