How do DeFi Lending Protocols Operate?
DeFi (Decentralized Finance) lending protocols are decentralized applications built on Ethereum that enable users to lend and borrow cryptocurrency without intermediaries. These protocols use smart contracts—self-executing contracts with the terms of the agreement directly written into code—to facilitate transactions.
Key Components of DeFi Lending
- Lenders: Users who deposit their assets into a lending protocol to earn interest.
- Borrowers: Individuals or entities seeking to borrow assets, usually providing collateral to secure the loan.
- Smart Contracts: Automated contracts that execute the lending and borrowing processes, including interest calculations, collateral management, and repayments.
Operation Process
- Deposit: Lenders deposit their cryptocurrency into the lending pool.
- Collateralization: Borrowers offer collateral, which is typically greater than the loan amount to mitigate risk.
- Interest Rates: Rates are determined algorithmically based on supply and demand. Lenders earn interest while borrowers pay it.
- Repayment: Borrowers repay the loan plus interest, after which their collateral is released.
Benefits of DeFi Lending
DeFi lending allows for greater financial inclusion, transparency, and accessibility, as users can operate globally and securely without the need for traditional banking infrastructure.