A Deep Dive into DeFi Lending and Borrowing
Decentralized Finance (DeFi) Development Services are gaining momentum with the rising population going digital. DeFi has a wide array of applications in the finance sector, out of which we will dive deep into DeFi Lending and Borrowing.
What is DeFi Lending / DeFi Borrowing?
DeFi protocols enable users to act as lenders or borrowers in a completely decentralized fashion ensuring the individuals have control of their funds. Decentralized Finance is backed by smart contracts that serve as a digital intermediary between lenders and borrowers.
DeFi Lending refers to crypto holders or lenders supplying their tokens or coins into the money market to lend funds to the users and earn passive income or interest on these assets. It is similar to traditional banking with a thin line of difference that DeFi lending operates peer-to-peer eliminating the third parties.
DeFi Borrowing refers to users taking a loan from the crypto holders on a decentralized platform through P2P lending. The borrowers offer an asset that can be summed equivalent to the loan amount to borrow the funds from the lender.
What is Asset Collateralization in DeFi?
Asset Collateralization is termed as a fundamental concept in DeFi, where the borrower pledges an asset for the lender to recover their capital if the borrower defaults on the loan. When a user borrows some assets from the liquidity pool, the user needs to provide the pool with some collateral. In case, the user fails to repay the debt to the pool, the lending protocol doesn’t repay the collateral to the borrower but instead uses the assets to repay the debt to the pool.
What is Asset Overcollateralization in DeFi?
The borrower on the DeFi platform must deposit a crypto asset that records a higher percentage value that the value of assets borrowed. It is beneficial to leverage asset overcollateralized loans for borrowers only if the end investment raises in value speedier than the interest on the debt. In case, the value of the collateralized asset falls below the total debt price, the borrower may not repay the loan causing it to become insolvent.
How Does DeFi Lending / Borrowing Work?
- DeFi Lending enables anyone to be a lender. A user holding Crypto assets on DeFi can lend the assets to others and earn interests on that loan.
- The lending process is carried out by the lending pools, where the users can pool their assets and distribute them to borrowers using smart contracts.
- Since a wide array of ways are available to distribute the interest to investors, the lenders need to research and identify their type. Also, the borrowers need to research lending pools as they have different approaches to borrowing.
- The borrower needs to deposit collateral via Smart Contract on the DeFi Lending platform that matches the value of the loan amount before borrowing the asset.
- The collaterals might vary from cryptocurrencies to tokens.
- There might be a possibility that the value of collaterals to drop down below the debt value. In this case, this will lead to a liquidation penalty.
Hopefully, the above article has enlightened you on DeFi Lending / Borrowing. If you have queries, feel free to connect with our experts.
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