The world of decentralized finance (DeFi) is gradually expanding to encompass a significant portion of the global financial lending space due to the inherently trustless mode of operation and ease of access to capital. As the crypto ecosystem has grown into a $2 trillion industry by market cap, new products and offerings have sprung up thanks to burgeoning innovation in blockchain technology.
Lending and borrowing have become an integral part of the crypto ecosystem, especially with the emergence of DeFi. Loans and borrowings are one of the basic offerings of the traditional financial system, and most people are familiar with the terms in the form of mortgages, student loans, etc.
In traditional borrowing and lending, a lender makes a loan to a borrower and earns interest in return for taking the risk, while the borrower provides assets such as real estate, jewelry, etc., as collateral to get the loan. Such a transaction in the traditional financial system is facilitated by financial institutions such as a bank, which take steps to minimize the risks associated with granting a loan by performing background checks such as Know Your Customer and credit scores before loan approval.
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Borrowing, lending and blockchain
In the blockchain ecosystem, lending and borrowing activities can be carried out in a decentralized way, where the parties involved in a transaction can deal directly with each other without an intermediary or financial institution through smart contracts. Smart contracts are self-executing computer codes that have some logic in which the rules of a transaction are embedded (encoded). These loan rules or conditions can be fixed interest rates, loan amount or contract expiration date and are automatically executed when certain conditions are met.
Loans are obtained by posting crypto assets as collateral on a DeFi platform in exchange for other assets. Users can deposit their coins in a DeFi protocol smart contract and become a lender. In return, they receive native tokens for the protocol, such as cTokens for Compound, aTokens for Have or Dai for MakerDao to name a few. These tokens are representative of the principal and the amount of interest that can be repaid later. Borrowers provide crypto assets as collateral in exchange for other crypto assets they wish to borrow from one of the DeFi protocols. Usually, loans are over-secured to account for unforeseen expenses and risks associated with decentralized financing.
Related: Looking to take out a crypto loan? Here’s what you need to know
Borrowing, lending and total value locked
One can lend and borrow through various platforms in the decentralized world, but one way to gauge the performance of a protocol and select the right one is to observe the Total Value Locked (TVL) on those platforms. TVL is a measure of assets staked in smart contracts and is an important indicator used to gauge the scale of adoption of DeFi protocols because the higher the TVL, the more secure the protocol becomes.
Smart contract platforms have become an important part of the crypto ecosystem and facilitate borrowing and lending due to the efficiency offered in the form of lower transaction cost, speed of execution higher and a faster settlement period. Ethereum is used as the dominant smart contract platform and is also the first blockchain to introduce smart contracts. TVL in DeFi protocols has increased by over 1000%, from just $18 billion in January 2021 to over $110 billion in May 2022.
Ethereum occupies more than 50% of the $114 billion TVL according to DefiLlama. Many DeFi lending and borrowing protocols are built on Ethereum because of the first mover advantage. However, other blockchains, such as Terra, Solana, and Near Protocol, have also increased their traction due to some advantages over Ethereum, such as lower fees, higher scalability, and greater interoperability.
Ethereum DeFi protocols such as Aave and Compound are among the most prominent DeFi lending platforms. But one protocol that has grown significantly over the past year is Anchor, which is based on the Terra blockchain. The major TVL-based DeFi lending protocols can be seen in the chart below.
The transparency provided by DeFi platforms is unmatched by any traditional financial institution and also allows permissionless access, which implies that any user with a crypto wallet can access the services from any part of the world.
Nonetheless, the growth potential of the DeFi lending space is enormous, and the use of Web3 crypto wallets further ensures that DeFi participants retain control over their assets and have full control over their data through crypto security. provided by the blockchain architecture.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.
The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of TNZT.
Neeraj Khandelwal is co-founder of CoinDCX, an Indian crypto exchange. Neeraj believes crypto and blockchain can revolutionize the traditional financial space. It aims to create products that make crypto accessible and easy for a global audience. His areas of expertise lie in the crypto macro space, and he also has a keen eye on global crypto developments such as CBDCs and DeFi, among others. Neeraj holds a degree in Electrical Engineering from the prestigious Indian Institute of Technology Bombay.