Understanding Lending & Borrowing in DeFi
Lending and borrowing have become core concepts of the crypto ecosystem, especially with the emergence of Decentralized Financing (DeFi) which is built on the blockchain.
23 JAN 2023, 4 min read
Slug Image

Lending and borrowing concepts are one of the core offerings of the financial system and include one party providing financial assets to the other party in exchange for a steady flow of income. Lending and borrowing have also become core concepts of the crypto ecosystem, especially with the emergence of Decentralized Financing (DeFi) which is built on the blockchain.

In the traditional sense, for lending and borrowing, the lender provides a loan to a borrower and earns interest payments for undertaking the risk associated with providing the loan. The borrower provides collateral in return and could include assets such as real estate, jewelry, or other assets as collateral to obtain the loan. In the traditional systems, such a transaction is facilitated by an intermediary such as a bank that conducts background checks including the KYC, credit score, etc., and minimizes the risks associated with such a transaction before approving a loan.

Lending and borrowing in the blockchain ecosystem are conducted in a decentralized system where the concerned parties deal with each other directly without an intermediary using smart contracts. These smart contracts form an integral part of the DeFi system and are essentially computer codes with a certain logic embedded in them that define the rules of transactions. These rules or policies could be in the form of the terms of a loan, interest payments, contract expiry dates, collateral, loan amount, etc. These smart contracts are self-executed upon meeting certain requirements that are embedded in them, for example, repaying interest and loan installments at pre-agreed intervals.

Measuring DeFi activity using total value locked (TVL)

Many platforms allow lending and borrowing in the decentralised world and one way to measure the platform activity and its performance is by the TVL on such platforms as the higher the TVL, the more secure the protocol becomes. Smart contract platforms have become a major part of the crypto ecosystem and Ethereum is used as a dominant smart contract platform which is also the first blockchain to introduce smart contracts. The TVL in DeFi protocols has grown exponentially over the past few years and currently stands at $87 billion according to the data from Defi Llama.

Total Value locked in DeFi

(Source: DeFiLllama)

TVL is an important indicator in DeFi and measures the assets that are staked in smart contracts. It is used to evaluate the adoption level of DeFi protocols and the higher the staked assets, the higher its adoption level. Ethereum blockchain comprises more than 50% of the TVL at $54 billion due to its first-mover advantage. However, with the developments and innovation in the space, other blockchains are also providing a supporting infrastructure to the DeFi that includes Solana, Binance Chain, etc. with improved capabilities such as lower fees, higher scalability, and more interoperability.

DeFi lending and borrowing protocols

DeFi protocols such as Aave, Venus, and Compound are some of the most prominent DeFi lending platforms. The top DeFi protocols based on Total Value Locked (TVL) are as follows:

Top DeFi Protocols by TVL

(Source: DeFiLllama)

Earning with DeFi Lending

DeFi allows an array of opportunities to earn passively through DeFi lending. The easiest way to do this is by depositing your available crypto on a platform or a protocol such as a crypto exchange or a DEX that pays out an annual percentage yield or APY. The process is very similar to depositing money into a savings account which pays out timely interests.

There are two ways that allow you to make money using DeFi lending: Liquidity mining or yield farming is the first one. One can get involved by staking or trading any rewards that they receive for depositing their cryptos which is usually the native token of the protocol. Also known as the governance tokens, these native tokens allow users to vote in the future developments of the protocol and vote for the required changes to the platform. These tokens are usually listed on the secondary market such as crypto exchanges for trading. The user has two options: one is to stake these governance tokens for earning future rewards on the issuing platforms or to trade them in the secondary markets just like stocks.

Another way to earn passive income through DeFi is borrowing a token from a platform that can be used to earn rewards either on the same platform or any other one. For example: if you are holding BTC in your wallet, you could take a portion of it, let’s say $2,000 worth of BTC and swap it with wBTC, depositing it on a DeFi platform. In turn, you will receive an APY depending on the rewards at that time, for example, 0.5%. Although this could sound like a small return, in return for depositing BTC, one could take a decentralised loan for another coin that might be offering a higher return.

Also Read: What is yield farming in DeFi?

(What are crypto loans?)

In a nutshell, after taking the loan, one could choose to deposit or lend it and unravel the potential of earning passive income on your crypto. While you will be earning APY, at the same time depending on the market condition, you will also benefit from the capital growth of the original asset and the interest earned. Hence, lending and borrowing in DeFi provide new ways of earning passive income through innovative financial instruments that are not offered in the traditional financial systems.


DeFi 101
All Blogs
Ready to get started?
Simply access your favourite token from multiple blockchains on a single DeFi app.

Empower yourself with DeFi
Interact with us
Follow us on Social Media and Join us on Discord