The DeFi lending platforms offer crypto loans in a trustless manner and allow users to enlist the crypto coins they have in the DeFi lending platforms for lending purposes. With this decentralized platform, a borrower can directly take a loan, called DeFi P2P lending. Moreover, the lending protocol even allows the lender to earn interest.
Why we need DeFi Lending
Getting profits from assets while still maintaining exposure to the upside of the assets.
A long-term crypto hodler who doesnât want to sell their crypto investment but still needs to pay for their bills may take out a loan on their crypto so they can pay for their daily needs. BTC mining farm operators may want to take out loans to buy new equipment instead of selling their BTC when the price is low.
Leveraged trading
A leveraged trade is a trade made with borrowed money. Margin refers to the collateral used to make the leveraged trade. Margin trading not only amplifies the investorâs loss or gain made on trade but also enables risk hedging like diversifying concentrated portfolios.
Earn Interest
Lending protocols serve holders with a better interest rate compared with traditional bank accounts, and it makes more customers access this passive earning opportunity.
Advantages of DeFi Lending
Transparency
DeFi Lending is facilitated by blockchain technology, which implies that it inherits the advantages of blockchain as well. As it is deployed on a public blockchain, the exact content of smart contracts is freely available and auditable for public users.
In addition, usersâ historical interactions with protocols and their lend and borrow positions are transparently recorded on the blockchain. The Market information is public to everybody.
Transparency ensures the security and authenticity of the system.
Liquidity
In conventional finance, the liquidity in lending mechanisms is sub-optimal. There are many factors like lending period and credit rating that make the liquidity of both demand and supply sides not properly served. The inefficient system makes the oversupply of liquidity in one submarket unable to be promptly transferred to serve the demand from another submarket.
In DeFi Lending, funds supplied to a lending protocol are pooled together and can be utilized efficiently. Because of smart contracts and blockchain, lending can be performed inexpensively and instantaneously.
Trustless & Permissionless
Regulations keep many people from lending services in traditional finance, and its centralized lending services result in a high intermediary cost, which causes high market friction and inefficient usage of market liquidity.
In DeFi Lending, lenders do not need to trust borrowersâ solvency at the most time, as the smart contracts automatically enforce the liquidation when default risk is present. By eliminating the middleman, DeFi Lending can limitlessly reach people around the world.
Popular DeFi Lending Platforms
Aave
Aave is a dual-token DeFi protocol based on the Ethereum network, considered the fastest-growing DeFi protocol. While it provides comprehensive financial services, Aave is prominent for its lending and borrowing among other offerings. It has the protocol native asset $LEND and interest asset aToken.
It has a hybrid lending system, which provides its users with both short-term stable and floating interest rate lending. The floating interest rate is determined by the offer and demand in Aave, and the short-term stable interest rate [1] is unchanged until the average borrow rate is lower than 25% APY and the utilization rate is over 95%.
In Aave, lenders will not enter into a deal with a specific borrower but they will send their assets directly into a liquidity pool. They receive the aToken as the return, which can be redeemed in a 1:1 ratio for the deposited asset. The number of aToken will gradually increase as the lender earns the interest rate.
For borrowers, they need to deposit collateral first before they can borrow from the protocol, which determines the maximum loan amount. The ratio is regulated by the LTV (Loan to Value) coefficient [2]. For example, If the LTV is 70%, the user needs to deposit 100 $ETH to borrow 70 $ETH.
Maker / Oasis
Maker is a dual-token system built on Ethereum using $MKR as a governance token, and the stablecoin $DAI for issuing loans. $DAI is created to function like actual money. As a stablecoin, it is soft-pegged to the US Dollar.
Unlike Aave and most other DeFi Lending protocols, Oasis only provides a borrowing service, and users can borrow its stablecoin $DAI from the protocol.
The protocol is governed by the Collateralized Debt Positions (CDP) system, which is a set of smart contracts that hold onto the collateral deposited by users to generate $DAI for borrowing. The presence of the debt locks the userâs collateral assets within the smart contract until the user is ready to pay back the amount of the $DAI they borrowed.
For borrowers, Maker offers stability in the volatile crypto market. Since $DAI is soft-pegged to the US Dollar and backed by a surplus of collateral locked in the protocol. When the market is highly volatile, Maker allows its users to store the value without abandoning their crypto positions.
TrueFi
TrueFi is a DeFi Lending protocol for uncollateralized on-chain lending.
Prior to TrueFi, most of DeFi lending protocols were utilizing over-collateralized lending, which is antithetical to the idea of borrowing and limited the mainstream adoption of DeFi.
The introduction of credit scoring to crypto is considered a paradigm shift for DeFi, without any doubt, it will improve the mainstream adoption of DeFi.
In TrueFi protocol, lenders can directly add their assets ($BUSD, $USDC, and $USDT) into a lending pool to be used to fund new loans, for which lenders earn interest and $TRU, the networkâs native asset. Any unused capital is sent to high-yield DeFi protocols (like Aave) for maintaining returns.
Borrowers (currently reserved to institutions only) are whitelisted through a rigorous onboarding process that involves a deep review of their business, the signing of an enforceable lending agreement, and $TRU communityâs approval. Once they are approved, borrowers will need to submit a request for capital at an interest rate and credit limit determined by their credit score, which is subject to further $TRU community approval. The Borrower must return the principal and interest on or before the term expired. Delinquent borrowers will face legal action pursuant to the loan agreement signed during onboarding.
For each loan, the $TRU community is required to signal their opinion on the loan by voting âYesâ or âNoâ. They are incentivized to vote on loans carefully, as their staked $TRU may be liquidated to protect lenders in case of default.
Notional
Notional protocol provides a fixed-interest rate for its investors, its working principle is similar to the zero-coupon bond in conventional finance markets that is issued and priced at a deep discount from its face value at maturity. Since its face value is predetermined, Investors can make a fixed return on their investment by purchasing a zero-coupon bond at the discounted price and redeeming it later for its full face value.
fCash token and its AMM liquidity pool are two major elements that compose the Notional protocol.
fCash is the zero-coupon bond in Notional protocol, which represents a claim on a positive or negative cash flow at a specific point in the future.
In Notional protocol, lenders and borrowers donât trade against each other directly, they trade against liquidity providers. These liquidity providers ensure that there is always cash and fCash available for either lenders or borrowers at any point in time and receive trading fees in return.
Conclusions
DeFi lending rapidly evolved after the DeFi summer. These protocols are continuing to extend the boundaries of their financial services in order to cover more customers that were abandoned by conventional finance. The paradigm shift from off-chain to on-chain financial services is still in its early days, but like the on-chain credit score system brought by TrueFi, the potential of the DeFi system is unlimited. The future of DeFi lending itself and the financial system incorporating with DeFi could lead to widespread adoption of DeFi by Fintech firms and the government. This DeFi would certainly lead to an open and simple financial system in the near future.
Updates After the Celsius Suspended its Fund Withdrawal (June.14.2022)
We have seen the collapse of Terra last month ends the fanaticism of algorithm stablecoin, and the Celsius now seems frustrating the future of CeFi.
Celsius offers varied interest rates based on the LTV ratio of the collateral provided by borrowers, the more collateral they provided, the lower rate they can access.
They managed their investorsâ deposits privately by distributing them into yield farming protocols (lending protocols)like Anchor. There are some rumors said Celsius lost a lot of funds during the collapse of Luna. As a CeFi company, it is impossible for investors to check what is happening internally at Celsius.
In this case, investors made a bank run against Celsius when hearing bad rumors under a panicky bear market, and forced Celsius to suspend its fund withdrawal.
The necessity of transparent fund management received more concerns when the Federal tightened their pockets and the inflation rate hits the moon. Vigilant investors in a bear market are now seeking protocols that they have more controllability rather than higher yields.
And the emergence of lending aggregators, like Fuji DAO, improves capital efficiency while maintaining DeFiâs transparency, and it will further undermine the market share of CeFi.
Disclaimer: This research is for information purposes only. It does not constitute investment advice or a recommendation to buy or sell any investment and should not be used in the evaluation of the merits of making any investment decision.
đŠ @SoxPt50
đ 15 June 2022
Reference
[1] https://medium.com/aave/aave-borrowing-rates-upgraded-f6c8b27973a7
[2] https://docs.aave.com/risk/asset-risk/risk-parameters
