The intriguing potential of blockchain has become the subject of close attention from all spheres around the world. In particular, the financial sector has been a leader in using blockchain capabilities to its advantage.
According to Coinmarketrate.com With almost $20.46 billion locked into DeFi protocols, the popularity of their apps has definitely grown by a significant margin. Decentralized financial loans have taken center stage among other applications on many popular platforms such as Compound, Aave and Maker.
The main prospects related to blockchain and cryptocurrencies point to the availability of financial services for everyone. Like traditional banks, crypto assets can provide similar financial services in a decentralized manner. Some of the common financial services mentioned in this case include lending, margin trading, sports trading and borrowing. Basically, DeFi refers to an ecosystem of financial services built on the basis of blockchain technology.
The technology offers freedom from interference by third-party intermediaries in access to financial services. Any loan report properly explained will show you how DeFi strives to offer a transparent ecosystem of open source and permission-free financial services. It is also important to note that smart contracts serve as the basis for DeFi due to their self-executing nature. Ethereum was the leader of this concept, and as a result, most applications are developed on top of Ethereum.
What are DeFi loans?
The first thing you need to know about decentralized finance loans is the definition of DeFi lending. Decentralized financial lending platforms are mainly focused on providing cryptocurrency loans without trust. According to the no-trust approach, users can lock their crypto assets on credit platforms without worrying about intermediaries. Borrowers can borrow DeFi loans directly from a decentralized platform through P2P lending.
In addition, the DeFi-borrowing protocol also helps the lender earn interest on crypto assets that they have blocked in the protocol. Interestingly, DeFi lending protocols have shown significant growth compared to other decentralized applications. In addition, DeFi lending is also responsible for blocking cryptocurrencies.
Differences between DeFi Lending and Traditional Lending
DeFi lending relies on the power of blockchain technology and uses all its exceptional features to increase productivity compared to traditional lending. DeFi loans offer a guarantee of full transparency along with easier access to assets at every transaction, without the involvement of intermediaries. They represent a simple and understandable borrowing process. Borrowers must create their accounts on the DeFi platform and have a crypto wallet. Thanks to the uncensored environment, DeFi ensures immutability without any preferences.
DeFi lending provides exceptional benefits for both lenders and borrowers. The possibility of using margin trading options can help long-term investors in lending assets to obtain higher interest rates.
In addition, they also help users access loans in fiat currency to borrow loans at lower interest rates compared to centralized exchanges. In addition, users can sell fiat currency on a centralized exchange for cryptocurrency, which they can lend on DEX.
The operation of DeFi Lending
The next important aspect for an effective understanding of the best DeFi loans, will point to the work of lending. One of the most important aspects of crypto assets will relate to their ever-changing value. However, your assets do not arouse interest when they are in your wallets. Thus, you could not get any income by letting your cryptocurrency idle in your cryptocurrency wallets. In this case, you will have to turn to decentralized financial loans.
DeFi lending helps users lend their cryptocurrency to another person and receive interest on the amount they have lent. Traditionally, banks have been the destination of any type of loan. If you needed a loan, you had to contact the bank. However, the growth of DeFi allowed anyone to become a lender, just like a bank. You can lend your assets to others and receive interest on the loan.
Like credit bureaus in traditional banks, DeFi loans depend on credit pools. Users can add their assets to credit pools and ensure their distribution among borrowers using smart contracts. Given the different types of interest distribution mechanisms among investors, it is important for lenders to determine the type of interest. Borrowers also need to conduct a proper study of credit pools, with each pool having different approaches to borrowing.
The most important aspect in working with loans, properly explained, is the issue of collateral for DeFi-lending. If you want to take out a loan from a bank, you need to make a deposit. Collateral is basically a security deposit that the bank may require if you do not repay the loan. For example, if you took out a loan to buy a car, the car serves as collateral. The bank may confiscate the car if you do not repay the loan on time.
DeFi lending also follows the concept of collateral, albeit with sharp differences from traditional bank loans. First of all, DeFi lending is anonymous, and the next interesting thing is that the decentralized system does not use any physical property as collateral. In the case of a decentralized system, borrowers must offer collateral more valuable than the loan amount. Smart contracts help to make collateral for loans of decentralized financing, which should be similar, at least, to the amount of the loan that you want to borrow.
You can discover various collateral options in the case of DeFi lending, and any crypto token can help you exchange the borrowed cryptocurrency. For example, if you want to borrow Bitcoin, you must deposit at least the price of one BTC, in terms of DAI. In addition, the constant fluctuations in the value of Bitcoins also raise concerns that the value of collateral will fall below the loan price. So, what to do in such cases?
Example of collateral issues in DeFi lending
Suppose a user wants to take out a loan of 100 DAI. It is important to note that MakerDAO requires a deposit of at least 150% of the loan value. So this clearly means that the borrower has to provide a $150 deposit in ETH for the loan. If the value of the collateral falls below 150 ETH, it will result in a liquidation penalty.
Advantages of DeFi Lending for Users
The benefits of DeFi lending are also another important aspect in understanding the value it brings to users. Here are some of the notable ways that the best DeFi loans help ordinary users:
- Increased speed of loan approval
The digital advantage associated with DeFi credits makes it possible for faster processing speeds. DeFi lending protocols support cloud services, machine learning algorithms, and analytics for fraud detection.
- Better consistency in decisions
DeFi lending brings consistency to lending decisions with clearly stated credit policy rules.
- No permission
Decentralized financial loans offer open and unrestricted access, allowing anyone with a cryptocurrency wallet to access DeFi applications. In addition, people could take out loans in DeFi without any geographical restrictions or the minimum amount of funds needed.
DeFi also offers prospects for high programmability with smart contracts that can provide automatic execution. In addition, it can also improve prospects for the development of new digital financial instruments and assets.
- Independent guardianship
Another important value advantage associated with DeFi loans points to opportunities for users to gain control over their assets. With Web3 wallets like Metamask, DeFi users can maintain tremendous control over their assets.
The next important advantage of DeFi lending points to the immutability of the blockchain. The decentralized architecture of the blockchain ensures data coordination without any concerns about unauthorized access. As a result, you can be sure of verifiability and greater security.
The last and most important advantage of DeFi lending protocols is compatibility. In this way, different protocols can easily integrate with each other to provide supporting functions. Interoperability plays a crucial role in DeFi lending, as you can block one type of cryptocurrency to get loans in another type of cryptocurrency.
Risks in DeFi lending
Having a clear understanding of the basics of DeFi lending, you could understand how profitable it could be. However, DeFi loans are not as easy as you think. You may find some notable risks associated with DeFi lending that may affect the way it is used. First of all, you should note that DeFi lending protocols provide a significant level of security.
However, hackers manage to exploit vulnerabilities in DeFi protocols to steal user assets. For example, the popular DeFi protocol, Value, revealed a sophisticated attack that compromised DAI stablecoins on the platform, estimated at almost $8 million. In addition, another DeFi protocol, Akropolis, also suffered $2 million in losses as a result of an attack using an approach similar to Value.
So, it’s reasonable to ask the question, “Are DeFi credits safe?” when you notice such huge attacks on protocols. In fact, the security of funds in DeFi protocols depends on the security of the underlying code. In addition, the risks of market movements are also responsible for insufficient provision of users. As a result, users may have to add more funds as collateral to avoid liquidation.
Borrowers should also consider concerns about over-securing their loans, as in the case of MakerDAO. Many borrowers deposit about 200% more than the loan amount they want to take out. When the price of the collateral asset begins to fall, the pool activates a circuit breaker. The pool cannot lose money, and will protect its funds at any cost. He can liquidate the collateral to cover the loan when the price of the collateral asset falls below 120% of the loan amount. Eventually, the borrower will receive the loan amount and lose the collateral asset.
The promising growth of DeFi in 2020 has definitely paved the way for the future of lending protocols. However, the future of DeFi loans will definitely bring a lot of opportunities and, at the same time, pose some new challenges.
Most DeFi-based projects attract the attention of investors, businesses and the general public with their advanced technical excellence. Lending protocols provide freedom from traditional intermediaries in financial services for borrowing and lending. Most importantly, they offer cryptocurrency holders an interesting opportunity to receive passive income or interest on their assets.
To be honest, there is no point in letting your crypto assets sit idle in your wallets. On the other hand, it’s also important to ask, “Are DeFi loans safe?” with so many hacker attacks in recent years.
At the same time, the growth of many new DeFi lending platforms, such as Compound and MakerDAO, points to favorable prospects for DeFi lending in the future. Learn more about DeFi lending and how it can completely transform financial services to understand its true potential.