Decentralized Finance lending – or DeFi lending for short – is a term you may have seen popping up everywhere in the financial technology world lately.
DeFi is a new way to borrow & lend money
DeFi lending is a revolutionary new way to loan and borrow money, without the need for a third party, or written contracts.
Rather than relying on paperwork or a middle-man to facilitate loan creation, DeFi lending instead uses automated systems – called smart-contracts – on the blockchain.
These smart-contracts use a series of pre-established rules to trustlessly arrange loans, calculate and transfer interest payments, and, if necessary, liquidate collateral.
For cryptocurrency holders, DeFi lending presents a smart and safe way to secure leverage, or simply collect interest on otherwise-idle digital asset holdings.
Top 3 DeFi Lending platforms
Compound.finance is currently the largest DeFi lending platform available, in terms of its current liquidity. The protocol currently holds almost $70m in assets, with a further $26m already being borrowed.
The Compound protocol is built on the Ethereum network, and specializes in the lending of Ethereum-based stablecoins DAI and USDC, as well as ETH itself.
Compound Finance is one of the only platforms which also supports lending markets for other tokens such as ZRX, BAT, and REP.
The platform has floating interest rates, which are continually recalculated according to supply and demand. Their interest payments are paid every block.
Lending periods are extremely flexible, with users able to withdraw their funds at any given time. There is no minimum limit on how long you lend your coins.
Dharma.io is also a protocol based on the Ethereum network.
Although it offers loans of DAI, USDC, and ETH in a similar way to Compound Finance and other platforms, it differs in the way that it structures its loans.
Interest rates are fixed, which means you know exactly what rate you’ll be receiving or paying for the entire duration of the loan.
This provides a more stable return, however, with Dharma you can’t withdraw your funds until the loan is terminated.
Dharma also offers an extremely user-friendly interface, making it simple and easy to lend or borrow cryptocurrency.
Unlike other platforms, dYdX.exchange offers an entire decentralized trading interface as well as typical lending and borrowing functionality.
On dYdX, funds can be directly borrowed via the trading interface and used for margin trading.
Like the others, the platform is built on Ethereum, and specializes in lending DAI, USDC, and ETH.
The markets available for trading are limited to ETH-DAI, ETH-USDC, and DAI-USDC.
Interest rates on dYdX are floating, and like Compound Finance, are adjusted regularly based on supply and demand.
Coins that you lend can be withdrawn at any time, and each loan is capped at a maximum period of 28 days.
DeFi Lending is already facilitating millions of dollars in loans
Average daily volume has grown about 3-fold in less than a year, showing a clear trend in the adoption of DeFi lending platforms.
Of the three platforms, dYdX tends to facilitate the largest volume of DeFi loans, with a whopping volume of USD$36.5m over the last month.
Compound’s new protocol captured $28.8m, while Dharma has provided $4.7m in loans originated over the last 30 days.
DeFi Lending vs Traditional Money Market
Although they are similar concepts, a variety of differences lie between DeFi lending and traditional money markets.
As you would have noticed, DeFi lending involves cryptocurrency only.
Whereas traditional money markets consist of fiat currency, DeFi lending systems require the use of currencies which are able to interact with smart-contracts.
Since Ethereum is the most widely-used smart-contract platform, most DeFi lending systems solely support ERC20 tokens, created on the Ethereum network.
Stablecoins such as DAI and USDC are popular on DeFi platforms as they provide this smart-contract operability, while remaining relatively stable (pegged to the US dollar).
In traditional lending, loans are often only partially-collateralized, collateralized with physical goods, or rely purely on legally-binding contracts. State legal systems are used to resolve disputes and liquidations.
DeFi lending, on the other hand, exists solely in the realm of the internet.
By design, it does not involve third parties or legal systems. Physical goods or paper-contracts are incompatible with DeFi protocols, which means that loans can only be secured with cryptocurrency.
In order to erase the risk of default and ensure repayment, all DeFi loans are over-collateralized with cryptocurrency.
Put simply, this means that a borrower must lock-up assets with a higher value than the amount that they are borrowing.
One can only participate in traditional money markets if they meet the criteria of local regulations and institutions.
This limits participation via a number of restrictions such as laws, capital requirements, lack of infrastructure, and more.
Individuals are also usually limited to operating only with people of their own geographical region.
DeFi lending, however, enables the participation of almost anyone with an internet connection.
You can participate no matter where you are in the world, and are not restricted by your wealth, identity, or location.
Traditional peer-to-peer lending often carries a relatively high risk of default, and disputes can be time and money intensive.
DeFi loans are designed to be very low-risk, via over-collateralization (covered above) and automated liquidation.
Any lending protocol is only as good as the infrastructure that it is built on.
This infrastructure is very different between traditional and DeFi systems.
If a DeFi smart contract contains any vulnerabilities, any currency stored within the contract may be at risk.
Most DeFi lending platforms have had their smart contracts rigorously audited by themselves and third parties, however sometimes bugs are overlooked.
Ease-of-use & Fraud
Banks and other financial institutions bring a valuable layer of trust and protection into money markets, which users are charged for in the form of fees.
Traditional money markets have their limitations, however, and at times one may wonder if these fees are justified.
Excessive paperwork, slow transactions and processing, and other shortcomings in traditional systems are all characteristics that traditional systems suffer from.
Smart-contracts in DeFi lending remove the need for these third parties. This eliminates paperwork and administration costs, and significantly speeds up processing times.
Cryptocurrency networks also enable users to transact at any hour of the day, any day of the week – something that is near-impossible with traditional money markets.
How to get started with DeFi Lending
All you need to get started with DeFi money markets, are an Ethereum wallet and a compatible currency!
The easiest way to interact with the systems is via the Metamask browser extension (if on a desktop or laptop computer). If you don’t have Metamask, or need a refresher on how to use it, click here.
Step-by-step with Compound Finance DeFi Lending
1. Begin by visiting the compound.finance official website, and click the “app” button. Alternatively, click here to go straight to the compound finance app interface.
You will be prompted to connect to the compound protocol, via a metamask popup which looks like this:
You will be greeted with a similar window for each step that requires interaction with the Ethereum network. Each of these steps involves a very small fee, to power these network requests.
2. Once you are connected to the app via Metamask, click the purple “enable borrowing” button.
3. You should see your balances pop up on the screen – if this does not happen within 30-60 seconds, refresh the page.
From here, you can select whichever token you wish to lend or borrow, by clicking it on the “available” list, in the lower half of the window.
For this example, we’re going to lend some Ether (ETH).
4. Click the green “Supply” button.
5. A pop-up window will appear, like the one above.
Select the amount you wish to supply for lending, then click “supply”, at the bottom of the window.
Again, confirm the contract interaction in the Metamask pop-up.
Once confirmed, your balance will be updated.
The coins you have supplied here can also be used as collateral for borrowing. You can view how much borrowing power you have, in the box in the top right of the window.
All you have to do now, is let it sit and watch the interest add up with each block!
To withdraw your Compound Finance balance
You may withdraw your balance at any time, as well as any interest earned.
This is just as easy as supplying money to the protocol.
1. To withdraw your lent money, click the grey “Withdraw” button, as seen above.
2.You will see another pop-up window, asking how much you want to withdraw.
Enter the amount to wish to withdraw from your account, and click “Withdraw” at the bottom of the pop-up window.
Confirm the contract interaction in the Metamask pop-up.
And there you have it! Money-back in your Ethereum wallet, plus interest!
Popular Cryptocurrencies used in DeFi Lending
Dai – A decentralized, Ethereum-based stablecoin
It is also the largest stablecoin that is NOT collateralized with fiat currency, which makes it very unique amongst its peers.
Rather than simply being backed 1:1 by US dollars, the value of the Dai token is stabilized via a smart contract with multiple mechanisms. These include over-collateralization in ETH, stakeholder incentives, and other automatic feedback mechanisms.
Despite the Dai-Maker system being a very new innovation, it has managed to hold its peg within a few cents of $1 for 99.9% of the time since it was created – even despite the price of Ether dropping 90% from all-time highs.
USDC – A fiat-collateralized stable coin by Circle & Coinbase
It is backed 1:1 with fiat currency, and exists as a token on the Ethereum network, allowing it to operate with smart contracts.
USDC is one of the fastest-growing stablecoins and has excelled in widespread adoption. It has grown to a market cap of almost half a billion dollars since its inception in October 2018.
This is largely thanks to its reputable owners in Circle and Coinbase, and the coin’s integration into their infrastructure.
Ethereum – Also known as Ether or ETh, native token of the Ethereum Network
Ethereum is a blockchain platform which enables the use of smart-contracts – a form of automated agreement or system – and has been around since 2015.
Ether is the “fuel” that powers the platform, and is used as payment for interacting with smart-contracts.
All of the above lending platforms are built on the Ethereum platform.
DeFi Lending is just getting started
DeFi lending is a relatively new concept, but the infrastructure is already live, easy-to-use, and thriving!
Decentralization and smart contracts have given DeFi lending the power to be quicker, more efficient, and lower-risk than many traditional lending methods, as well as being available to anyone with an internet connection.
Whether you want to coordinate a leveraged strategy, or simply earn interest on cryptocurrency that you have lying around, protocols like Compound Finance, Dharma, of dYdX Exchange can help you.
Additional DeFi lending reading –