A Quick Guide to DeFi Loans
Today, everyone is aware of the fact that how the financial industry has been revolutionized by Decentralized Financial (DeFi). By offering decentralized financial services by the leverage of Blockchain technologies, DeFi envisions, and strives to bring a transformation in the existing financial sector.
As the central authorities managed the whole functioning of the financial industry, the need to decentralize the largely centralized financial market was genuine. This paved the path for the origin of Decentralized Finance (DeFi).
Automated lending and borrowing of crypto loans is one such use-case of DeFi. In a very short period of time, this field gained intense prominence in the cryptosphere. Hence there is a great deal of mystery and enthusiasm involved amongst the users as well as investors.
What are the DeFi loans?
The Defi loans are collateralized loans offered as collateral to a borrower in return for his crypto assets. Once all parties agree to a particular interest rate on the loan, the swap of crypto loans occurs between the lender and the borrower.
The amount of the crypto loan is deposited in the bank account of the borrower and then the borrower pays EMIs to the lender, as in the case of a conventional loan. The lender releases the collateral that has served as security until the balance is paid back in full.
On DeFi lending platforms, Defi loans are usually carried out where lenders and borrowers can communicate directly without any intermediary being present.
What Benefits does DeFi Lending offer over Traditional Lending?
DeFi lending uses all its special functionality and, relative to conventional lending, performs incredibly well. In each money transfer process, DeFi provides full transparency and faster access to the asset for users without involving any third party.
You just need to build an account on a DeFi lending platform, have a crypto wallet, and open smart contracts when it comes to the borrowing process. In addition, DeFi is immune to censorship, meaning that there is no unfair treatment thus maintaining immutability.
It supports both lenders and borrowers. It provides unsupported platforms with margin trading opportunities and helps long-term holders to lend their money and receive higher interest rates.
In addition, consumers who have access to fiat currency credit will borrow it at a cheaper cost than decentralized exchanges and sell it on a centralized exchange and then finally lend it to the decentralized exchanges for earning an arbitrage fee.
How are Loans made?
Using a smart contract found on projects such as Ethereum helps users to pool their assets and transfer those assets with the loan rules written into the contract to borrowers.
These loan pools have their own way of assigning interest to each lender, so it is worth taking the time to explore the sort of pool in which you would like to engage as an investor. For borrowers, this same guidance holds as each pool will take a different approach to how to borrow from their assets and the borrowing rules.
If a borrower goes to a bank to get a loan, they need collateral on the loan. However, since a decentralized system is anonymous, it has no real property that can be used as collateral.
How Do DeFi loans Work?
No interest is accrued from crypto assets remaining in a wallet. The underlying value can increase or decrease, but by owning the particular cryptocurrency, you’re not earning anything. This is where DeFi loans come in.
Imagine being capable of lending someone else your crypto and gaining returns on the loan. This is how banks actually operate, but it is a facility that few people can use. Anyone may become a lender in the world of DeFi.
You are able to generate leverage on those investments by loaning the crypto assets to others. There are wide ranges of ways of doing this, but loan pools are the main way. Essentially, they are the loan offices of a conventional bank.
They have to offer something more valuable than the value of the loan when a borrower decides to take out a loan. That means they need to deposit an amount of currency that is at least equal to the amount they would like to take out with a smart contract.
Advantages of DeFi loans
1) Transparency- Smart contracts manage the lent and borrowed funds instead of a centralized entity and store them for anyone to check in the blockchain. It, therefore, provides total transparency in the flow of funds.
2) Easier access to assets- DeFi loans facilitate peer to peer lending and borrowing as there is no middleman. This enables direct transfer of assets giving users much easier access.
3) Greater Speed, Utility, and Versatility- You need to build an account on a DeFi lending platform to carry out the transactions, and it takes only a few seconds to access the smart contracts. Using your mobile and in just a few minutes, all these can be checked.
4) Price Efficiency- Consumer demand determines the prices of assets. Thus, DeFi’s ability to easily draw more customers due to ease of entry, the potential for arbitration, and clarity in financial disclosure facilitate price efficiency.
5) Censorship Resistance and Immutability –Decentralization ensures there is no unfair treatment and equal right to information and opportunity are maintained, with transactions saved in blockchain promising immutability.
Use Cases
1) Single platform for crypto asset lending: Crypto loans are the most powerful approach and the most used feature of the crypto-lending markets-a single forum for crypto-asset lending.
2) Non-taxable liquidity- The easiest way to escape taxation on gains is to secure crypto loans against their collateral to earn fiat currency. This is profitable instead of the holders who would like to keep the crypto assets in their account.
3) Arbitrage Lending- Crypto loans give you the ability to borrow an asset from one platform and lend the asset to another in Arbitrage Lending.
4) Margin trading- A customer can achieve leverage by acquiring a crypto loan, purchasing extra collateral, etc. without the need for a centralized exchange.
5) Flash loans- To perform other operations, users can borrow crypto loans and then pay back the loan at the end of the full transaction.
Challenges
1) Higher interest rate– The interest rate for DeFi space borrowing is actually comparatively higher. for example: For, USDC it is 6-10 %, for DAI it is around 17.5 %. Depending on the countries, the global interest rate for borrowing varies. The US maintains an average interest rate of around 5-6 %, many countries charge interest rates of 10-20 %, with several charging higher rates.
2) Economy Unable to Influence– If there is insufficient liquidity, this limits lending and saving at the existing interest rate without influencing equilibrium interest rates effectively. This adds to DeFi not being able to control the economy and thereby replicating it sufficiently.
Popular Defi lending platforms
1) Compound
COMPOUND is a decentralized Ethereum-based blockchain protocol for the effective borrowing of Ethereum tokens that provides a safe and constructive solution to digital asset management. This in turn removes the shortcomings of current traditional methods.
It sets up money markets to deposit and loan funds and operates without manipulating interest rates or collateral. Suppliers and borrowers are able to communicate with the protocol explicitly and receive a floating interest rate
2) Maker
Maker is a special DeFi crypto lending network that allows only DAI tokens to be lent, and for use as collateral, it only allows ETH and BAT for now, which makes it unique from the protocol of Compound. By “governance fees,” which serve as network interest rates, MKR empowers users to participate in operational earnings.
Users lock their collateral with Maker into a core Maker smart contract called Collateralized Debt Position (CDP) to create DAI with Maker.
3) Aave
Aave is a DeFi open-source lending protocol that has gained widespread use among users since its 2020 introduction on the mainnet. Through this network, lenders may deposit the cryptocurrencies in the pool funded by the framework and obtain an equal sum of aTokens (similar to the Compound protocol’s cTokens).
Aave also algorithmically changes the interest rate based on demand and availability, meaning that the more tokens you carry, the greater the amount of interest.
4) BlockFi
BlockFi, a non-bank lending portal, provides compound interest and the capacity to exchange BTC, ETH, LTC, USDC, and GUSD crypto pairs. It is backed by lenders such as Coinbase, Galaxy Digital, Valar, and more. It is, however, somewhat regulated and shares similarities between traditional credit systems
5) Nexo
Nexo offers automated crypto-to-fiat loans, all without having to liquidate assets. It also further provides crypto-to – crypto loans, as well as a revolutionary instant credit line that features a real credit card that borrowers can use in their daily lives, The card itself is directly linked to digital assets stored in your Nexo wallet, without credit checks and no minimum payments.
The Future
Cryptocurrencies function as perfect collateral and they are readily saleable and liquidated as the crypto liquidations take place in seconds. Crypto loans will be an important part of its success and glory, looking at the pace at which the crypto industry is rising.
The Defi loans are open to anyone with an internet connection, which ensures that anyone can buy and lend crypto. This is further bringing a rise in its popularity. But it is better to do the proper research before determining if it is the best thing for you to take out a crypto loan.
Conclusion
Thus it is clear that Defi will be able to reshape the whole financial system, transforming the environment for good. DeFi is seeking to decentralize core conventional finance, such as payment, transfers, and banking, but also needs to resolve the technical and operational risks associated with it.
