DeFi lending platforms make it easy for investors to borrow against their existing holdings for a range of use cases without selling their assets.
Crypto Borrowing Rates for November 2024
| Token | Aave v3 | Aave v2 | Spark | MakerDao | Compound |
|---|---|---|---|---|---|
| USDC | 3.33% | 18.84% | 5.06% | 0% | 0% |
| USDT | 15.24% | 13.43% | 16.92% | - | 0% |
| WETH | 1.19% | 1.93% | 1.23% | 6.75% | 0% |
| WSETH | - | - | - | - | - |
| WEETH | 0% | - | 5% | - | 0% |
| WBTC | 0.77% | 1.01% | 0.47% | 9.75% | 0% |
| DAI | 5.86% | 13.99% | 6.29% | - | - |
Why do People Borrow Crypto?
Borrowing crypto is popular for several strategic reasons. These mostly boil down to two key concepts: Obtaining leverage and avoiding taxable events.
Obtaining Leverage
Users can borrow against crypto holdings to create synthetic leveraged positions in the market.
For example, a user can borrow stablecoins against ETH, and use those stablecoins to purchase more ETH (or another asset) for greater exposure.
Conversely, a user could borrow ETH against stablecoins, to immediately short-sell on the open market. They can then buy back this ETH at a discount, pocketing the difference.
Avoiding Taxable Events
Borrowing against cryptocurrency holdings can provide a user with quick liquidity, without selling their assets outright.
This is useful because it avoids a taxable event from selling crypto, but still provides the borrower with liquid funds.
Some centralized platforms allow users to borrow fiat currency against their crypto holdings. These platforms are less common in 2024, following several centralized lenders going bankrupt in 2022.
DeFi Borrowing Protocols
Aave
Blockchains supported: 12+ networks
Collateral Tokens: Wide range of stablecoins, ETH, LSTs, and popular DeFi tokens
Borrowable Tokens: GHO and all collateral tokens
Additional features: Flash loans, GHO stablecoin, staking.
Aave is a lending protocol on Ethereum and 11+ other blockchains. It lets users borrow various cryptocurrencies, which mostly consist of stablecoins, ETH, liquid staking tokens (LSTs), and popular DeFi tokens.
Loans are overcollateralized to protect lenders, with interest rates that adjust automatically based on supply and demand.
Aave also features flash loans with a fee of 0.05% and its stablecoin, GHO, backed by assets in version 3 of the protocol.
MakerDAO
Networks supported: Ethereum and Gnosis Chain
Collateral Tokens: ETH, LSTs, WBTC, stablecoins, and some DeFi tokens
Borrowable Tokens: DAI stablecoin only
Additional features: Dai Savings Rate (DSR).
MakerDAO is a stablecoin protocol on the Ethereum and Gnosis Chain that allows users to borrow its stablecoin DAI, by locking up major Ethereum-based tokens as collateral.
It primarily accepts ETH, ETH LSTs, WBTC, and stablecoins with a 110-200% collateralization ratio.
DAI is pegged to the US dollar and generated through overcollateralized loans managed by MakerDAO’s smart contracts.
Governance is handled by MKR token holders, who vote on changes to protocol parameters. Users can also stake DAI for the Dai Savings Rate (DSR) – a fixed interest rate set via governance.
Compound
Blockchain supported: 6+ networks
Collateral tokens: Popular DeFi tokens
Borrowable Tokens: ETH, Tether, USDC, and bridged USDC.
Compound is a lending protocol on Ethereum and 5+ other networks, allowing users to borrow and lend popular DeFi tokens.
Users can borrow a handful of major assets against ETH, stablecoins, and popular DeFi tokens. Interest rates are dynamically adjusted based on supply and demand, and loans are overcollateralized to protect lenders.
Compound’s governance is decentralized, with COMP token holders voting on key protocol changes and whitelisted assets.
Spark
Blockchain supported: Ethereum and Gnosis Chain
Collateral tokens: sDAI, stablecoins, ETH and ETH LSTs, and WBTC
Borrowable tokens: DAI and collateral assets (except for sDAI).
Spark is a protocol on Ethereum and Gnosis Chain that enhances the DAI ecosystem as an add-on to MakerDAO.
Its core offering, SparkLend, is a lending protocol based on Aave V3. It’s designed to enable users to borrow DAI and a range of tokens against sDAI – a token representing DAI staked in the Dai Savings Rate contract. Despite this focus, users can also lend and borrow a variety of stablecoins, ETH LSTs, and WBTC.
The Spark SubDAO manages governance, allowing the community to propose and vote on changes using the SPK token.
Morpho
Networks supported: Ethereum and Base
Collateral tokens: Any ERC20 on Ethereum or Base, via permissionless market creation.
Borrowable tokens: Any collateral token.
Additional features: Free flash loans, MetaMorpho layer.
Morpho is a newer lending protocol on Ethereum and Base that aims to offer enhanced efficiency, flexibility, and scalability.
In contrast to platforms like Aave and Compound, Morpho Blue is minimally governed – instead, users can create their own markets. This includes customized lending and borrowing parameters and externalized risk management for any ERC20 token.
The customization allows for higher collateralization factors, better interest rates, and lower transaction costs. Pricing is oracle-agnostic and bad debt is socialized among lenders to prevent bank runs.
An additional layer, MetaMorpho, automates and decentralizes risk management for a more user-friendly, passive experience.
Getting a DeFi loan is simple, provided you already own some cryptocurrency. No identity verification is required.
Here’s how it works:
- Set up a web3 wallet: Ensure you have a Web3 wallet compatible with your blockchain network of interest.
- Visit a DeFi platform: Go to a DeFi borrowing app that supports the tokens you’re interested in.
- Provide collateral: Deposit a supported cryptocurrency as collateral.
- Borrow: Borrow your desired token against the deposited collateral.
And that’s it! You now have a DeFi loan.
Ensure you repay the loan as soon as you’re done with the funds, to avoid further interest payments or liquidation.
What type of leverage can you get on a DeFi loan?
The type of leverage you can get on a DeFi loan typically depends on the platform and the specific collateral you provide.
Most DeFi platforms require over-collateralization, meaning you must deposit more value in collateral than the amount you wish to borrow. Common collateralization ratios range from 110% to 200%, meaning for every $100 you borrow, you need to deposit $110 to $200 worth of collateral.
Another way the borrowable amount is commonly expressed is via “loan-to-value” (LTV) ratio – the inverse of the collateralization ratio above. A 60% LTV ratio means you can borrow up to 60% of the value of your collateral.
Overcollateralization is important since it ensures the loan can be repaid in full, even in a volatile market.
What are Flash Loans?
Collateral required: None
Conditions: Funds must be fully repaid within the same block
Fees: Typically 0% to 0.05%.
Flash loans are a type of unsecured DeFi loan where users can borrow money and return it within a single block.
If the loan doesn’t return the entirety of the funds within a single transaction, the entire transaction is reversed – ensuring no risk to the lender. Due to this absence of repayment risk, no collateral is required for a flash loan.
On the other hand, using a flash loan typically requires smart contract writing ability. The loan and the subsequent use of funds must be programmed to complete complex operations within one transaction.
Flash loans are popular for arbitrage, collateral swapping, and refinancing without the need for traditional collateral.
What are the risks of DeFi Borrowing?
Liquidation Risk
Liquidation risk comes from the volatility of collateral assets. If the value of your collateral drops significantly, especially during a market downturn, your assets may be automatically sold off to repay the loan.
Smart Contract Risk and Exploits
Smart contract risk involves the potential for bugs or vulnerabilities in the code of the DeFi protocol.
Any vulnerabilities can cause malfunctions on their own, but are sometimes also maliciously exploited – in other words, hacked. These can result in the loss of user funds, fraudulent access to protocol treasuries and governance, and other undesirable outcomes.
Major protocols perform smart contract audits and carry out bug bounty programs to minimize these risks.
Oracle and Price Feed Risk
Oracle risks in DeFi borrowing occur when the external data sources that provide asset prices malfunction or get manipulated.
This is a common attack vector used for hacks and exploits. A faulty oracle can lead to incorrect pricing information, resulting in unfair liquidations or under-collateralized loans.
Largest DeFi Borrowing Hacks
Several billions of dollars have been lost in DeFi exploits to date, commonly leveraging flash loans to fund the attacks.
Although these have assisted in exposing holes in smart contracts and improving coding standards, it’s been a costly learning curve.
Here’s a look at the top 5 largest DeFi lending platform hacks so far:
In April 2022, Beanstalk was attacked using a flash loan. The attacker gained control of governance and passed proposals to transfer $182 million worth of funds.
In October 2021, Compound faced a critical issue due to a protocol bug. This bug led to the distribution of excess COMP tokens, putting $150 million in tokens at risk.
Also in October 2021, Cream Finance suffered a flash loan attack. The attacker exploited a pricing vulnerability, causing a loss of $130 million in deposits in the third attack on the protocol.
In November 2021, bZx was compromised due to a private key breach. This resulted in a loss of $55 million in funds deployed on Binance Smart Chain and Polygon.
In September 2021, Vee Finance (Avalanche) was exploited through its leveraged trading feature. The attacker created trading pairs on decentralized exchange Pangolin, draining $35 million through leveraged trades.
FAQ
A DeFi loan is a loan that users can take out by providing cryptocurrency as collateral on a DeFi lending platform. These loans are typically overcollateralized to protect lenders.
DeFi lending carries risks such as liquidation risk from collateral volatility, smart contract exploits, and Oracle risks, which vary depending on the platform and assets involved.
The vast majority of DeFi loans are overcollateralized. This means that the value of the funds borrowed must be less than the value of the funds provided as collateral.
Typical collateralization ratios range from 110% to 200%.
DeFi borrowing is decentralized, using smart contracts on blockchain platforms to facilitate cryptocurrency loans without intermediaries. Traditional loans involve fiat currency and financial institutions as intermediaries, with more rigorous processes.
DeFi borrowing typically involves digital assets only, whereas traditional loans focus on fiat currency.
You can borrow crypto with no money via flash loans. These are unsecured and must be repaid within a single transaction.
Flash loans typically require smart contract writing ability, to code specific operations within one block.
