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What makes blockchain and cryptocurrencies so appealing in recent years in the financial markets is that they are used and made available to everyone? How does DeFi lending work? Let’s find out.
DeFi offers all finance services as same as the traditional banks system, but in a decentralized form, including lending, borrowing, spot trading, and margin trading.
People can quickly and easily borrow money by DeFi loans. They will not have to disclose their identity to a third party or perform complicated checks like in the banking system.
What is DeFi Lending?
DeFi lending allows people to borrow or deposit money and receive a certain interest rate. However, borrowing on DeFi does not have the intervention of a financial intermediary.
DeFi lending systems allow anyone to borrow crypto assets without an intermediary. Anyone who owns a cryptocurrency can lend on DeFi and make a profit. Due to being based on a Peer-to-peer network, loans will be made directly to lenders, reducing reliance on intermediaries as well as reducing costs.
How does DeFi Lending work?
- When you own a cryptocurrency in your account, this money will not be profitable. The number of money increases or decreases depending on the financial market. Therefore, DeFi loans with high-interest rates are an attractive investment channel for crypto investors.
- Crypto owners can lend to others and earn interest on them. It’s like a traditional bank that lends money to people. But on the DeFi system, you will not have to go through complicated verification procedures like at the bank. Anyone can be a lender or a borrower.
- There are many ways to make DeFi lending, but the most common way is through loan groups.
- Financial services for loans, borrowing, electronic money transactions, investments, etc. implemented on DeFi through the blockchain platform.
- DeFi is characterized by decentralization and anonymity.
- Interest is created by lending other crypto assets to others. Usually, lending takes place within the lending group.
- Lenders have the right to claim collateral.
- The collateral assets of the borrower must always be greater than the borrowed money.
How are loans made?
Through smart contracts, decentralized financial systems allow lenders to transfer assets to borrowers with separate rules outlined in contracts.
The lending groups will have rules for the distribution of interest rates for each investor. If you are looking to get into the crypto loan market, you should invest a lot of time researching each type of loan group to understand the different rules.
Usually, you need collateral if you want to get a loan from the bank. For example, if you borrow money to buy a house, the house will become collateral. If you cannot afford the loan, the bank will own your home.
In decentralized financial system:
– Anonymous lender.
– The borrower has no physical assets to mortgage.
So the decentralized financial system has different principles for protecting lenders. A borrower needs to deposit something greater than a loan. DeFi requires borrowers to deposit an amount at least equal to the amount they wish to withdraw. On a decentralized financial system, collateral can be in many cryptocurrencies, such as Bitcoin.
Over the years we have all seen fluctuations in the value of different cryptocurrencies in the market. So what happens if your collateral goes down and falls below the value of your loan?
MakerDAO requires borrowers to mortgage a loan of at least 150% of the loan value. Let’s say you want to borrow 100Dai. That means you will have to mortgage your loan with a minimum amount of $150 in Ether (ETH). If your collateral is worth less than $150 ETH, your loan will be penalized upon liquidation.
Benefits of DeFi lending
In addition to generating regular income from lending crypto assets, DeFi Lending also offers other great benefits.
- Margin trading: Users can buy an electronic asset and then use it for an exchange on another exchange to get other cryptocurrencies. This will help reduce the steps after borrowing money to find a place to buy crypto and then bring it to the exchange, instead we can borrow and transact costs through intermediary steps.
- Long-term Investment Reward: If you do not intend to use your electronic assets in the near future, execute a loan agreement on DeFi platforms. You will earn a large amount of interest.
- Difference between DEX and CEX: Take advantage of low-interest rates on DeFi to borrow money. Use borrowed money to invest in other CEX products with higher interest rates. From there you earn the difference between the loan fee and the loan.
The challenges of DeFi lending
Usually, the borrower will be asked to mortgage a loan that is larger than the desired loan value. When the price of the cryptocurrency begins to fall below the allowed level that the borrower has deposited, the system will liquidate the collateral to pay off the loan. It means that the borrower does not lose the number of crypto-currencies, but the value of their crypto-currency will fall.
If you are speculating that the price of crypto-currency will skyrocket, you could make a profit and possibly pay back the loan by becoming a borrower.
Some risks when joining DeFi Lending
– Fake smart contract
– APY’s change in a short period causes borrowers to go bankrupt without responding in time
– In the process of entering information into the system, errors may be caused by the user
– There is no way to get back the lost money if there is an error or mistake in the lending process.
Conclusion
Decentralized financial systems are working relentlessly to make their services better than other traditional financial services. Decentralized finance system services have one great advantage of being available to anyone with an Internet connection.
According to MarketWatch, the crypto lending market could reach $8 trillion over the next 2 years. And also according to data from Defipulse shows that DApps lending accounts for the largest market share in DeFi platforms.
With an impressive growth rate even in the current condition of Covid-19 disease, DeFi lending can be seen as a very attractive investment and receiving positive attention from investors.
However, investing in crypto is also a risky investor’s adventure. So do your research thoroughly before deciding if a crypto-currency loan is right for you or not.
