What is Lending & Borrowing? The indispensable Shard of DeFi puzzle

In traditional finance, when a business needs capital to expand production or launch new projects, they typically think of borrowing from banks or credit institutions. However, in the cryptocurrency market, the concept of borrowing and lending also exists, but with significant differences. Specifically, users in the Crypto market can borrow and lend without going through financial intermediaries like banks, and can conduct cross-border transactions without previous barriers. So what is Lending & Borrowing? Let's explore this with Allinstation today!

What is Lending & Borrowing?

Lending & Borrowing in the DeFi field is one of the most popular and important applications. This allows users to borrow and lend cryptocurrency assets without going through intermediary organizations like banks or credit companies.

Simply explained, if you own Bitcoin (BTC) or Ethereum (ETH) and just keep them in your wallet, your assets won't generate income unless the price changes. However, with DeFi Lending platforms, you can increase profits from these assets through two main forms:

• Depositing BTC and ETH into Lending platforms to lend and receive annual interest rates.
• Using BTC and ETH as collateral to borrow stablecoins, then seek profits from trading or yield farming.

Lending & Borrowing Models

Lending Pool

Users deposit assets into a pool (Liquidity Pool) on a DeFi platform, where loans will be executed. Borrowers can deposit collateral assets into the pool and borrow other assets from here. Interest rates in the pools will change depending on market supply and demand. Notable platforms in this model include AAVE, Compound, Solend, and Apricot.

CDP (Collateralized Debt Positions)

Platforms like MakerDAO allow users to collateralize assets (such as BTC or ETH) to create stablecoins (like DAI). These stablecoins can be used to participate in various protocols and blockchains.

Under-Collateralized Lending

This is a lending model where borrowers do not need to collateralize assets of higher value than the loan amount. This model is similar to margin trading but more flexible. This opens up opportunities for users who do not need large-value assets to borrow.

Over-Collateralized Lending

Borrowers must collateralize assets of higher value than the loan amount. These assets will be held in a smart contract and only returned when the loan is fully repaid.

How Lending & Borrowing Works

Components in Lending & Borrowing

• Lender: Individuals or organizations owning cryptocurrency assets and wanting to lend to earn interest.
• Borrower: Individuals or organizations needing cryptocurrency assets for use or investment. They must meet the requirements of the DeFi platform.
• DeFi Platform: Software application or protocol on Blockchain, providing an environment for Lending and Borrowing.
• Smart Contract: Self-executing program on Blockchain, establishing and executing loan terms, including asset conversion, interest calculation, risk management, and asset liquidation.
• Lending Pool: Funds consisting of cryptocurrency assets deposited by lenders and used to provide loans. Lenders earn profits from interest when contributing to these funds.

Summary of Lending & Borrowing Operation Process

Lenders will interact with Smart Contracts through DeFi Platform to provide assets to Lending Pools. Borrowers borrow assets through Lending Pool by interacting with Smart Contract on DeFi Platform. Assets of both Lender and Borrower are managed by Smart Contract to ensure fairness and transparency in transactions.

Role of Lending & Borrowing

Lending & Borrowing in DeFi not only helps users earn additional profits from cryptocurrency assets but also opens new opportunities for Web3 investors. Transactions do not require KYC but ensure information transparency, enabling users to participate in financial activities without being controlled by traditional financial institutions. Additionally, Lending & Borrowing is a platform for more complex financial tools in the future like Derivatives, providing the ability to optimize profits and protect against risks.

Risks of Participating in Lending & Borrowing

Market Volatility

When the market experiences strong fluctuations, especially in deep decline situations, Lending and Borrowing participants will be significantly affected when assets are locked in the project's Money Pool. This leads to limited risk management, asset value reduction, and capital loss when investing in the Crypto market for Lenders, and asset liquidation for Borrowers.

Rug Pull

Rug Pull is a fraudulent action in the crypto industry, where a development team suddenly abandons a project and sells or withdraws all of the project's liquidation. This term originates from the phrase "pull the rug out from under (someone)", meaning "crossing the bridge and pulling the plank". Rug Pull is a common action in DeFi because tokens can be easily created and then listed on DEX without KYC or AML.

Flash Loan Attack (Hack)

A Flash Loan attack is a type of exploit that uses the temporary liquidity provided by Flash Loan to manipulate prices or steal assets. steal assets. Flash Loan is a type of loan that allows borrowers to borrow money without providing any collateral. The loan must be loanated in a single transaction block, otherwise the borrowed amount will be automatically returned.

Summary

Lending & Borrowing opens up a new and flexible financial worldeFin the DeFi space. This is a powerful tool that helps users optimize profits from cryptocurrency assets without the intervention of intermediaries. However, it is also necessary to note the potential risks in the process of participating in these protocols.

Hope with this article, Allinstation has helped you understand Lending & Borrowing in Crypto better!