What Is DeFi?
Decentralised finance (DeFi) is a new way of handling money and financial services without the need for traditional financial (TradFi) intermediaries like banks or institutions. Instead of relying on middlemen to manage financial transactions, DeFi uses self-executing computer programmes, called smart contracts, on blockchain networks, primarily Ethereum or Solana.
In other words, with DeFi, users can lend, borrow, trade, or potentially earn interest on their digital assets directly, without having to enter a bank. That’s what DeFi aims for. These services run 24/7 and are accessible to anyone with an internet connection, a digital wallet, and sufficient funds to provide as collateral or to lend.
For example, a user could lend their cryptocurrency to earn interest, trade one type of cryptocurrency for another (or with another user), or get a loan by putting up cryptocurrency as collateral. All these transactions happen automatically through smart contracts, which are intended to be like digital vending machines that can’t be tampered with.
While DeFi offers exciting possibilities for making financial services more accessible and efficient, it’s important to note that it’s still a relatively new technology. Lending is one of the most popular aspects of DeFi, and in this article, we take a closer look at how it works, its advantages and risks, and how to use DeFi Lending with Crypto.com.
What Is DeFi Lending?
DeFi lending is a decentralised financial service that allows users to borrow and lend cryptocurrencies without intermediaries, using smart contracts on blockchain networks. It offers participants the potential to earn interest on their assets or access funds by providing collateral, all within a transparent and trustless ecosystem.
How Does DeFi Lending Work?
As described above, DeFi lending is a way to borrow or lend cryptocurrency without going through TradFi institutions. With DeFi lending, lenders deposit their cryptocurrency into a lending pool on a DeFi platform like Aave or Compound. These lenders earn interest on their deposits, often at rates higher than traditional savings accounts. The interest rates automatically adjust based on supply and demand — when more people want to borrow, the interest rates rise.
To borrow from these platforms, users need to provide collateral, usually in the form of other cryptocurrencies. This collateral is typically worth more than the amount they want to borrow — a practise called overcollateralisation — usually one-and-a-half to three times or more. For example, a user might need to deposit $150 worth of ETH to borrow $100 worth of another cryptocurrency.
The smart contract automatically manages the entire process, holding the collateral, transferring the borrowed funds, tracking repayment terms, and handling interest calculations. If the value of the collateral drops too low (due to cryptocurrency price fluctuations), the smart contract can automatically liquidate the collateral to protect the lenders.
One unique aspect of DeFi lending is that loans are typically ‘flash loans’, short-term loans that are borrowed and repaid within the same blockchain transaction without any collateral provided up front. These can be used for trading opportunities or moving assets between different platforms.
Advantages of DeFi Lending
Below are the main advantages of DeFi lending:
1. Higher Interest Rates
Lenders can typically earn higher interest rates compared to traditional bank accounts or savings accounts. Rates can range from 2%–20% APY or even higher, though they fluctuate based on market conditions.
2. Accessibility and Inclusivity
Anyone with an internet connection and sufficient cryptocurrency can participate in DeFi lending. There’s no need for bank accounts, credit checks, or extensive documentation. This makes financial services available to people who might be excluded from traditional banking.
3. Speed and Automation
Loans are processed instantly through smart contracts. There’s no paperwork, approval process, or waiting period. Everything happens automatically and is available 24/7.
4. Transparency
All transactions are recorded on the blockchain and can be verified by anyone. Smart contract code is typically open-source, allowing users to understand exactly how the system works.
5. Flexibility
Users can borrow or lend multiple types of cryptocurrencies, often with flexible terms. They can also withdraw their deposited assets at any time, unlike traditional fixed-term deposits.
6. No Intermediaries
By removing banks and other middlemen, DeFi lending reduces costs and eliminates the need to trust centralised institutions with a user’s money.
7. Composability
DeFi protocols can interact with each other, allowing for complex financial strategies and the ability to earn returns from multiple sources simultaneously.
Risks to Consider
Below are key risks associated with DeFi lending:
1. Smart Contract Vulnerabilities
Smart contracts can contain bugs or security flaws that hackers can exploit. Once money is stolen through a smart contract hack, it’s usually impossible to recover. To mitigate this risk, only use well-known and reputable platforms that offer high levels of security. Crypto.com offers the highest security standard in the crypto industry.
2. Collateral Liquidation Risk
If the value of a user’s collateral suddenly drops, their position could be automatically liquidated at a loss. Given cryptocurrency’s high volatility, this is a significant risk — users might lose a substantial portion of their collateral due to a brief market downturn.
3. Cryptocurrency Volatility
The value of both a user’s collateral and borrowed assets can fluctuate. For lenders, interest income at a 20% interest rate may not be able to compensate for the decline in the price of cryptocurrencies if the underlying asset loses 50% of its value.
4. Impermanent Loss
When providing liquidity to lending pools, a user might experience ‘impermanent loss’ if the relative prices of the paired assets significantly change.
5. Gas Fees
On networks like Ethereum, high transaction fees (gas fees) can make small lending positions unprofitable or prevent a user from quickly responding to market conditions.
6. Counterparty Risk
While smart contracts automate the process, a user is still reliant on other users providing liquidity and maintaining healthy collateral ratios in the system.
DeFi Lending With Crypto.com
Crypto.com’s DeFi Lending feature is now live in the Crypto.com App, giving users another way to potentially earn passive income. Users can now lend their assets on DeFi protocols and receive interest with no term limits.
The feature currently supports ETH lending on Aave, with more assets and protocols to come.
See here for more details and the latest rates.
Conclusion
DeFi lending represents a groundbreaking shift in the way we think about borrowing and lending, offering transparency and opportunities to potentially earn passive income. While the rewards can be significant, understanding the underlying risks is essential for traders to make informed decisions and safeguard their assets.
By carefully researching platforms, staying updated on market trends, and starting with a cautious approach, traders can harness the potential of DeFi lending.
Due Diligence and Do Your Own Research
All examples listed in this article are for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, cybersecurity, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by Crypto.com to invest, buy, or sell any coins, tokens, or other crypto assets. Returns on the buying and selling of crypto assets may be subject to tax, including capital gains tax, in your jurisdiction. Any descriptions of Crypto.com products or features are merely for illustrative purposes and do not constitute an endorsement, invitation, or solicitation.
Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a crypto asset, it’s essential for you to do your research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.
What Is DeFi Lending?
Learn how decentralised finance (DeFi) lending platforms can offer users potential passive income and access to loans without needing intermediaries.
- Decentralised finance (DeFi) lending empowers users by removing traditional intermediaries, offering a more inclusive and decentralised way to borrow and lend assets.
- By lending crypto assets, users can potentially earn competitive interest rates while contributing liquidity to the DeFi ecosystem.
- Transactions are managed by smart contracts on public blockchains, ensuring transparency and trustless interactions.
- DeFi lending platforms cater to various needs, from stablecoin lending for more predictable returns to innovative yield strategies with more volatility and higher earning potential.
- DeFi Lending is available to Crypto.com App users as a way to potentially earn passive income. Users can now lend their assets on DeFi protocols and receive interest with no term limits.
Get your step-by-step guide to setting upan account with Crypto.com
By clicking the Submit button you acknowledge having read the Privacy Notice of Crypto.com where we explain how we use and protect your personal data.
