How does lending work in DeFi?
Decentralized finance, or DeFi, has gained a significant level of attention in recent times as it has garnered massive amounts of capital.Lending applications are a popular way to use digital assets in DeFi. This article explains the basics of how lending works in DeFi.
What is DeFi lending?
DeFi allows any user to become a borrower or lender without having to hand over personal information for verification. Everything is handled through smart contracts.
Lenders can deposit assets into a lending pool, and borrowers will borrow from that pool. At any time, lenders can redeem the escrow assets and borrowers can repay part or all of their debt. Borrowers can choose to borrow from one of these protocols and post collateral.
Loan ceilings are determined by two factors:
- The amount deposited by creditors in the financing fund of the protocol.
- The quality or ” collateral factor ” of the coins deposited by the borrower.
The higher the collateral, the higher the loan amount can be, for example, if ETH has a collateral factor of 75% and 10 ETH is placed as collateral, the investor can borrow an amount worth up to 7.5 ETH.
What are the benefits of DeFi lending?
- Loan Approval Speed: The digital advantage associated with DeFi lending presents the opportunity for faster processing speed. DeFi lending protocols have support for cloud-based services, machine learning algorithms and fraud detection analytics.
- No Restrictions: Decentralized financial lending allows anyone with a crypto wallet to access DeFi applications. In addition, people could make loans in DeFi without geographical location barriers or minimum amount of funds required.
- Asset Custody: Another important advantage associated with DeFi loans indicates the opportunities for users to gain control over their assets. With the help of Web3 wallets like Metamask, DeFi users could maintain major control over their assets.
What are the risks?
Risks associated with DeFi lending come mainly from smart contacts. Backers can exploit the vulnerabilities of a Smart Contract to steal funds.
Also, users should be very careful with wallets and addresses. Sending money to the wrong wallet or losing your private key means the funds are lost forever.