By Admin November 25, 2022 4 minute read
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Posts » Learn The Basic Concepts Of DeFi Lending And
Borrowing
Table of Contents
·
Concept of DeFi lending and borrowing
·
Asset Collateralization in DeFi
·
Asset Overcollateralization in DeFi
·
Pros and cons of DeFi lending and
borrowing
· Final thoughts:
Future of DeFi lending and borrowing
The possibility of using
blockchain technology in the development of financial applications has improved
with the introduction of DeFi. Decentralized Finance, or DeFi, has recently
gained a lot of attention since it has raised huge amounts of capital for
numerous businesses.
You might be amazed by
the fact that about $20.46 billion is currently locked in DeFi protocols,
indicating a sharp increase in demand for DeFi applications.
Naturally, this has spiked the idea of DeFi lending and borrowing.
In this blog, let’s have
a look at DeFi lending and borrowing.
Concept of DeFi lending
and borrowing
Two basic elements on
which any financial organization work includes both lending and borrowing. Most
people face a situation where they have to borrow money at some point in their
lives, whether it be for college loans, a home, or a car.
The entire lending and
borrowing process is really straightforward. Borrowers get funds from lenders,
usually referred to as depositors, in exchange for a percentage of their
deposits. Borrowers are generally known as loan takers. In exchange for
receiving a lump sum payment immediately, they are prepared to pay interest on
the amount they get.
Traditionally, financial
institutions like banks offer lending and borrowing services. However, they are
under the control of centralized systems run by government authorities and
gatekeepers. Due to this, regular customers are required to interact with a lot
of intermediaries to get their funds.
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And DeFi challenges this
centralized financial sector by removing the need for any third party.
DeFi lending and
borrowing give customers ultimate control over their money while allowing them
to become lenders or borrowers in a totally decentralized and seamless way. It
is built on open blockchains called “smart contracts,” the most popular of which
being is Ethereum.
While it is common
knowledge that Crypto assets fluctuate, holding them idly in wallets will not
generate money. In such a situation, DeFi enters the scene.
DeFi loans allow you to
earn money by lending borrowers your Crypto assets. Anybody could be a lender
now, thanks to DeFi. As a result, you can lend your funds to others and
generate revenue from the loan.
Smart contracts enable
investors to gather their Crypto assets and distribute them to borrowers. There
are numerous methods available for distributing the funds. Therefore, it is
advised to conduct your own research to determine the best type of investing.
Due to the wide variety of easily accessible alternatives, the same is true for
borrowers.
When applying for a loan
from a typical financial institution, you need collateral that can act as
security for the loan you require. The decentralized ecosystem offers the same.
The primary difference is that the system is anonymous and does not use any
tangible property as collateral.
The fact that any
digital asset can be used as collateral should not be ignored. For example, if
a user wants to borrow one BTC, he must deposit the cost of one BTC in LTC.
There are two terms
related to DeFi lending and
borrowing that you should learn about. They are described below:
Asset Collateralization
in DeFi
Asset Collateralization
is a core concept in DeFi, where the borrower guarantees an asset that the
lender can recover their capital in case the borrower is incapable of repaying
the loan. The liquidity pool requires some form of security or collateral
whenever a user borrows assets from it. If the user fails to pay back the debt
owed to the pool, the lending protocol will not repay the collateral to the
borrower; instead, it uses the assets to pay back the debt owed to the pool.
Asset
Overcollateralization in DeFi
Asset
Overcollaterization is another core concept of DeFi. What happens here is that
on the DeFi platform, the borrower is required to deposit a Crypto asset with a
higher percentage value than the value of the assets borrowed. Borrowers should
only leverage asset overcollateralized loans if the final investment increases
in value more quickly than the debt’s interest rate. The borrower might be
unable to repay the loan, which would cause the borrower to become insolvent if
the value of the collateralized asset drops below the total debt price.
Pros and cons of DeFi
lending and borrowing
PROS
· DeFi borrowing and
lending are more efficient at disbursing loans.
· DeFi protocols have
better transparency as they are open-source in nature.
· No one’s permission is
required to apply for a loan.
· There is no requirement
for KYC procedures and data sharing.
· DeFi is anonymous and
totally decentralized.
· This is a fantastic way
to use your Crypto assets to generate passive income.
· Borrowers must
overcollateralize to guard against unexpected price drops.
CONS
· Smart contracts are
susceptible to malicious attacks that look to take advantage of programming
errors.
· Due to worries about
money laundering, governments might not be in favor of no-KYC lending and
borrowing.
· Law enforcement agencies
around the world may be concerned about anonymity.
Final thoughts: Future
of DeFi lending and borrowing
The previous few years
have seen phenomenal growth in DeFi lending and borrowing. 2023 will bring new
challenges, but there are also many great opportunities. As more investors
engage in cutting-edge financial technologies, several initiatives based on
DeFi are gaining traction.