What are DeFi Loans – How does Defi Lending Work?

Snapshot:

• Introduction
• What is DeFi
• What is DeFi Lending
• What is the difference between DeFi Lending and Traditional Lending
• How does DeFi Loans Work
• What are the advantages and disadvantages of DeFi Loans
• How do DeFi Lending platforms help the Financial Service Sector
• Top DeFi Lending platforms
• Conclusion

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Introduction

The main purpose that blockchain and the crypto space is catering toward is reducing the third-party involvement in any transaction that takes place. Providing financial freedom is what the blockchain protocols have been collectively working towards, popularly known as DeFi or Decentralized Finance.

What is DeFi?

Decentralized finance (DeFi) is a movement that is used to leverage the decentralized networks such that the old financial products are transformed into transparent and trustless protocols that can run without any middlemen. It is also the umbrella term for various projects and applications in the blockchain space that possesses the potential to disrupt the financial world. DeFi consists of peer-to-peer protocols that are developed on this decentralized network for easy trading, borrowing, and lending of financial tools. According to market data, the current big lenders in the market are Maker and AAVE.

Also Read: What is Crypto Lending?

What is Defi lending?

DeFi Lending is usually platform based where investors can get access to loans without any intermediaries. Not only do they have a process set for loans without any third-party involvement, but also has an option to enlist their crypto tokens for lending purposes! Using the P2P method of lending, a borrower can directly take a loan from the decentralized platform. Amongst the various decentralized applications, often called DApps, available; DeFi has the most steady growth rate in lending. 

Also Read: HOW IS DEFI BETTER THAN TRADITIONAL FINANCE?

What is the difference between Defi Lending & Traditional Lending?

If we seek a deeper understanding of why DeFi ending has seen steady growth in recent times, the first and the most important point would be the underlying technology of DeFi; i.e., blockchain. The usage of blockchain in DeFi lending not only negates the involvement of any third party but also makes sure that the transactions take place almost without any obstacle.  The process of borrowing and lending in DeFi is also pretty straightforward. The participant had to follow only the following three steps:

• Create an account in a DeFi platform.
• Create a crypto Wallet
• Open Smart Contacts.

While the participant if following the step, DeFi makes sure that it provides an equal opportunity to every user, all while ensuring immutability. Both Lenders and Borrowers get to benefit from this method. They get access to margin trading options, and long-term investors can lend their assets and stand a chance to earn higher interest rates. This also enables users to access their fiat currency credit to borrow loans at lower rates than decentralized exchanges.

How does DeFi Loans Work?

Crypto assets in your wallet do not generate any interest if not put to use. Though the underlying value of the assets may increase or decrease, just holding particular crypto will not lead to any earnings. This is where DeFi loans come into play. DeFi loan is a method that enables users to lend their crypto as a loan while earning interest on the loan. Unlike in traditional finance, anyone in the DeFi realm can become a lender. All you need is a certain amount of any crypto token and a borrower looking to take out a loan! The easiest way to do this is via lending pools.

What Are The Advantages & Disadvantages Of DeFi Lending?

Though DeFi lending is based on blockchain technology, it also has certain advantages that help smoothen the loaning process, and certain disadvantages that require thorough research from the participants before diving in.

Advantages

• The loans granted within DeFi are consistent. All the rules are already set which leaves little to no room for human error.
• As the underlying technology behind DeFi is blockchain, it provides absolute transparency to any and all transactions taking place while a loan is granted.
• Quick execution of loans as there is no delay due to credit checks, which is usually the case for traditional loans.

Disadvantages

• DeFi lending sometimes incurs impermanent losses. Impermanent loss takes place when there is a change in the price of the crypto locked in a liquidity pool. This event usually takes place when there is an uneven token ratio in the liquidity pool.
• As the DeFi ecosystem is not fully regulated, there are chances of certain rug pulls; where the DeFi developers abandon one token to make a new one. These incidents are often commonly termed as crypto scams.

How do Defi Lending platforms help the financial services sector? 

The DeFi Lending platform helps the Financial Service sector in the following ways:

• Savings 
• Lending and borrowing
• Tokenizations
• Stablecoins
• Asset management
• Insurance
• Decentralized Exchanges (DEX)

Top DeFi Lending Platforms 

The DeFi Lending marketplaces have seen steady growth in the crypto ecosystem with a rise in many new innovative platforms. With our discussion of what DeFi Lending is and How DeFi Loan works, it is also important that we take a look into some of the most well-known DeFo Lending platforms today.

• AAVE: One of the top entries among the best DeFi loans protocols is Aave. Aave’s decentralized liquidity market platform is non-custodial in nature, and the users could participate in the protocol as borrowers or depositors. Depositors also play a very crucial role in driving liquidity in the market for earning a passive income on the asset. Here, borrowers can procure loans in under-collateralized or over-collateralized manners. 
• Compound: It is often referred to as the best DeFi loans application. The Compound ecosystem leverages a money market approach for borrowing and lending applications. Lenders could deposit a specific amount of crypto in lending pools and earn interest without any fixed loan duration. They have also brought a new governance system for community governance, which now enables users to suggest, debate, and implement suggestions and new developments.
• Maker: Maker from MakerDAO is another notable addition to fetch the best DeFi loans. Maker’s decentralized governance platform is powered by DAI, which has the target price at $1, thereby qualifying as a stablecoin.

Conclusion

The deep dive in to DeFi loans and DeFi lending has clearly stated the potential this sector has in reshaping the financial system. The decentralized nature of the function makes DeFi Loans that much more appealing and its handshake with the blockchain technology makes it an attractive option for individuals to explore. Being deeply involved with crypto, DeFi Loans also require a thorough understanding and research before they are explored. 

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Disclaimer: Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. In case you have any queries, write to [email protected].

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