What is DeFi Lending?
Understanding how protocols like Aave let you earn yield and borrow against your crypto - without banks or intermediaries.
The Basics
DeFi (Decentralized Finance) lending is exactly what it sounds like: lending and borrowing money, but without banks. Instead of a traditional financial institution, smart contracts on the blockchain handle everything automatically.
Think of it like a peer-to-peer lending pool where:
- Suppliers deposit crypto and earn interest
- Borrowers put up collateral and borrow crypto, paying interest
- Smart contracts manage everything - rates, collateral, liquidations
How It Works: A Simple Example
Your ETH goes into the lending pool and starts earning interest immediately.
If ETH = $3,500, your 10 ETH = $35,000. You can borrow up to $28,000 in other assets.
USDC goes to your wallet. You pay interest on it but keep your ETH exposure.
Return the USDC + interest, and your ETH is fully available again.
Why Borrow Instead of Selling?
This is the key insight: borrowing lets you access cash without giving up your position.
If You Sell Your ETH:
- • Trigger taxable event
- • Miss future price gains
- • Need to buy back later at higher price?
If You Borrow Against ETH:
- • Keep your ETH position
- • Benefit from price increases
- • Pay small interest fee instead of taxes
Interest Rates
Unlike traditional banks with fixed rates, DeFi rates are dynamic - they change based on supply and demand:
- High demand to borrow → Rates go up (more interest for suppliers)
- Low demand to borrow → Rates go down (cheaper for borrowers)
Typical rates as of 2024: Stablecoins (USDC/DAI) often pay 3-8% APY to suppliers, while ETH/BTC pay 1-3% APY.
The Key Risks
Liquidation Risk
If your collateral value drops too much relative to your debt, you get liquidated - your collateral is sold to repay the loan, and you lose a penalty (usually 5-10%).
Smart Contract Risk
Your funds are held by code. While major protocols like Aave are heavily audited, bugs or exploits can happen.
Variable Rates
That 5% borrow rate could spike to 20% during high demand. Always monitor your positions.
Protocols Like Aave
Aave is one of the largest DeFi lending protocols with over $10 billion in deposits. It runs on Ethereum and other chains, offering:
- Support for 20+ tokens as collateral
- Flash loans (borrow and repay in one transaction)
- E-Mode for correlated assets (higher LTV)
- Safety Module for protocol insurance