Decentralized lending protocols are a modern blockchain method to borrow funds without middle men like the banks or other institutions.

Picture taking a loan as a situation where the bank / financial institutions pools together money from other users and lends it to you without the other user's knowledge or participation. But now with Decentralized lending protocols, you can borrow funds directly from blockchain users on the same protocol.

There are Centralized Finance (CeFi ) protocols out there that also have lending and borrowing options, but with them users do not have full control over their funds, instead the protocol lends out your funds to third parties in your place. These platforms are often susceptible to risks like hacking, theft etc.

Decentralized Finance (DeFi) protocols on the other hand allows users to have full control over their funds at any time even as you are borrowing from and lending to other users. This is done via self executing contracts which provide an automated system for lending and borrowing.

HOW DOES THIS WORK??

When a user lends their cryptocurrency (the funds here are cryptocurrency and token) on an DeFi protocol, their tokens are deposited in a smart contract. This smart contract makes these tokens available for other users to borrow and in return the lender receives interest tokens (often native to the protocol) which can be used to redeem other assets.
This provides lenders steady income while giving liquidity to the protocol.

For borrowers on the other hand, they must provide collateral in order to secure their loan. (I bet you didn’t expect it right??). This collateral comes in the form of other cryptocurrencies which should be above the loan value. This over-collateralization mitigates the risk of defaulting on payments and it makes a lot of sense because borrowers might not want to sell their cryptocurrencies due to potential future value appreciation and with the borrowable amount being determined by the platform’s liquidity and the value of the collateral, this helps maintain a dynamic balance between lenders and borrowers and ensures the stability of the DeFi ecosystem.

POSSIBLE RISKS AND CHALLENGES

Every practical innovation or technological advancement comes with its own risks and DeFi protocols are not left out.

One of the most prominent of DeFi risks is related to the Smart Contract. Although they are designed to be secure, apparently there's always a possible loophole that can be exploited by hackers or presence of bugs and errors in the code which can lead to significant losses bothe to the protocol , and the users. Therefore, we should only engage with well-audited and reputable protocols.

Also due to the inherent volatility of the crypto market, the worth of borrower's collateral can increase or decrease with crypto rise and fall and could lead to a potential liquidation of their assets. This is particularly challenging for borrowers as they might have to pay back their loans earlier than expected or provide additional collateral.

COMPOUND AS A DeFi LENDING PROTOCOL

Compound Finance is a popular accessible smart contract protocol built on the Ethereum blockchain. It allows users to borrow and lend their crypto assets within the protocol.

It is an innovative one as you get a collateral in form on cTokens when users have locked in their funds in the protocol. COMP token is the DeFi platform’s native token and supports a wide range of assets on the Ethereum blockchain.

There are several other DeFi protocols like Aave, InstaDApp , etc.
To read up on more of them , kidly use the link below:

https://coingape.com/defi-lending-platforms/

Anticipate my next article where we would discuss Marinade Finance, mSOL (Marinated solana ) tokens and their use cases amongst other DeFi interests.

STAY SAFU