The blockchain has made it possible to decentralize cryptocurrency transactions. DeFi (or decentralized finance) proposes to pursue and offer financial tools that are also decentralized. It is already possible to borrow or lend, but also to save. And all this in a decentralized way and without intermediaries. I’m sure you’re wondering how this can be possible, here are some first answers.
This article is part of the file “Cryptocurrencies, the big folder”
Lending with DeFi
Become a borrower
It is possible to borrow and lend through the blockchain. But while this is simpler than taking out a loan from the bank, there are certain constraints for it to work. Indeed, both parties must be covered. And since these are automated and anonymous contracts, conditions must be met.
If you want to apply for a loan from your bank, you will have to provide a certain number of documents. You will need to indicate your marital status, your salary, your level of indebtedness… so that the bank can study this and grant you the loan or not.
None of this of course in DeFi. But for the lenders to have a guarantee, it will be necessary to leave a deposit, also called “collateral”. This deposit will be higher than the amount requested. Said like that, it’s weird. At first glance, one might wonder why borrow less than what is left as security. Especially since it will be necessary to pay, as in a conventional loan, interest. But what you need to know is that the deposit is left in cryptocurrency, and that can be recovered against the FIAT currency. Let’s say you think Bitcoin is going to explode in the coming days or weeks. You will be able to apply for a loan to obtain dollars by leaving bitcoins as security. With these dollars, you can, for example, buy bitcoins. And if bitcoin sees its price rise sharply, you will indeed come out of it greatly and doubly a winner.
Let’s take a concrete example. Bitcoin is at $50,000. You have 2, which you leave as a deposit. Knowing that the deposit is therefore $100,000, you will be able to borrow approximately $75,000. With this $75,000, you buy bitcoins (so 1.5 additional bitcoins). If the price rises to $80,000, your 1.5 bitcoins purchased through the loan are therefore worth $120,000. This means that you can easily repay the loan with interest, and still have a lot of profit. And the icing on the cake, the 2 bitcoins that you left as a deposit and that you recover are now worth $160,000. On the other hand, it is easy to understand that this little game is risky if ever the bitcoin suffers a fall.
There may be other cases also for investment purposes. For example, you mine bitcoin, you need funds to buy equipment. You leave as security the bitcoins you have to buy back your equipment. As the latter gives you a return on investment, you can pay off your loan.
We said that it was therefore possible to borrow a certain sum, leaving more than what is borrowed as security. The idea is to secure the loan so that you have interest in paying it back with interest. But what if the cryptocurrency you left as collateral sees its price drop? This is a very important point, because it could cause you very bad surprises. At that time, if your loan is no longer covered by your collateral, the blockchain will sell your deposit to cover your loan. It’s called a liquidation. It is therefore necessary to monitor the courses to see if your collateral is still in the nails, otherwise it will be sold.
Become a lender
It is also possible to become a lender. There, the advantage is to be able to count on an interest rate to make your cryptos work passively. These interest rates are not fixed, and depend on supply and demand. Depending on the platforms, in addition to the rate, you will also be able to receive tokens from this platform via a rate there too.
For example, on the Aave , which is one of the DeFi benchmarks, you will also receive interest in a percentage of tokens. This is also true whether you are a lender, or if you are a borrower.
For example, as I speak to you you can find this on the AAVE home page:
At the top left, you have the “market size”, namely the amount currently stored on the AAVE blockchain. Important to know because the more important it is, the more likely it is that the project will be serious and properly audited.
At the top right, you have different buttons allowing you to switch from one market to another (Ethereum protocol, Polygon, Avalanche…). This can be important because on the Ethereum network the fees can be significant.
And below, you have the different assets. For each one you will have its capitalization (market size), the total borrowed, the rate for a deposit (here 5.5% on the DAI, plus 1.11% in AAVE token), the rate for a loan (here 7.59% on the DAI, but you will earn 1.38% in tokens).
You then have buttons allowing you to launch a deposit or a loan.
Know that it is possible to chain several actions to increase earnings (borrow to deposit, to re-borrow). This can be interesting, but it is complex to mount and you have to take all the parameters into account. If you ever want to know a little more, here is a concrete example in video, with the Excel workbook allowing you to do the calculations
It is also possible to save. This is essentially the same as for a loan. The idea is to generate passive income via interest. We then speak of staking. I invite you to read the article on this blog on how to generate passive income by mining, via a masternode or staking .
You will find many players within DeFi. The list is of course constantly evolving because things move very quickly in the sector.
At the level of loans, we have mentioned AAVE , we can also mention Compound . Among the exchanges, we can cite Uniswap , which makes it possible to exchange ERC20 tokens in particular, and which is widely used in the context of exchanges linked to DeFi.