A Guide to collateralised loans in DeFi

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DeFi

One of the goals of cryptocurrency and blockchain innovations is to make all financial industry tools available to all. This is why DeFi lending is one of the fastest-growing sectors in the cryptocurrency and blockchain industry. It is the sector of cryptocurrency that encompasses the entire process of making, saving, trading, saving, lending, borrowing and sending money, but in a decentralised form. 

Keeping your cryptocurrency in your wallet doesn’t earn you any interest except for an increase or decrease in its price, which will, in turn, impact the value. This is where the DeFi loans come into play. 

DeFi Lending

DeFi lending allows users to deposit their crypto-asset into a protocol like in the traditional cash investment that accumulates interest over time. However, apart from earning interest on their digital asset, lenders also receive a governance token or DAI as an extra benefit. 

DeFi loan offers a 3-5% interest for lenders, which is more than what you get from traditional banking systems. One of the most essentialities of DeFi lending is that it helps you eliminate the dangers of market volatility since users passively earn capital without trading.

DeFi Borrowing

In the traditional financial industry, a borrower must provide collateral equal to the loan amount. This is slightly different in the DeFi loan system. When a borrower wants to take a loan, they have to offer an asset of more value than the loan amount. 

That implies that the lender will need to deposit an amount of currency equal to the value to take out. The collateral can be in a wide variety of currencies. So if you want to borrow bitcoin, you’d need to deposit the current price for one bitcoin in DAI. Or 11,296 DAI. This collateral is returned once the borrower repays the loan plus 10% interest.

DeFi Collateralised Loan Risks

Everything about DeFi lending looks good and safe when compared with centralised finance. However, like every other finance protocol, DeFi has risks. For instance, DeFi lending is prone to certain smart contract risks and the threat of APYs changing dramatically within a short time window. 

For example, during the DeFi boom of 2020, where “yield farming” became so popular, borrowing APYs on specific cryptocurrencies skyrocketed to 40% and more. This implies that borrowers who fail to keep track of the incurred interests may end up paying more than they expected. 

Furthermore, while the entire process DeFi collateralised loans seems easy, there are certain minor differences in terms of how each specific DeFi protocol operates, for example, the various wallets they support, applicable fees, etc. 

Overall, users still have to be cautious and ensure that they have inserted the correct wallet numbers and address details to avoid losing their money – which, in this case, is irrecoverable. 

Final Thoughts

Defi lending is on course to redefine the entire financial system. It seeks to decentralise the foundational traditional finance services like payments, trading, investments, insurance, loans. Defi lending being involved with the fascinating technology has vast opportunities to revolutionise the global financial landscape.