June 2, 2023
Decentralized Finance (DeFi) has been a disruptive force in the financial sector, and DeFi Lending is at the center of this change. Blockchain technology is used by DeFi lending platforms to provide decentralized borrowing and lending services. Crypto lending/borrowing was the largest growing area of DeFi in 2021, accounting for almost half of the total wealth locked in DeFi.
The Decentralized Finance market was worth $45.33 billion in January 2023. It is predicted to increase to more than $231 billion by 2030, with a compound annual growth rate (CAGR) of 42.5% beginning in 2022. One of the primary reasons for this rapid development rate is the ability of DeFi systems and protocols to eliminate middlemen.
Between December 2022 and January 2023, DeFi's Total Value Locked (TVL) grew by $5.39 billion in 30 days. Meanwhile, registered DeFi customers were over 6.68 million as of January 2023, representing a 1.5 million user gain over January 2022.
Aave, Maker, Compound, are among the major DeFi lending platforms as of 2023. These platforms have continued to draw in huge capital deposits, with the top three platforms holding almost $40 billion in TVL.
Despite the enormous potential provided by DeFi financing, there are many hazards such as smart contract flaws and market instability. For example, huge losses have occurred as a result of vulnerabilities in smart contract programming. Before engaging in DeFi lending, users should take prudence and do rigorous research and due diligence.
Financial risk refers to the difficulty in measuring the risk of DeFi investments due to a lack of comprehensive historical data and benchmarks. Traditional investors often analyze investment prospects using historical data and benchmarks such as yearly inflation in their native currency and the risk-free rate of return. Due to the sector's newness and a lack of comparative data, such evaluation becomes challenging in the framework of DeFi.
This risk originates from the likelihood of a counterparty failing to satisfy their obligations. Counterparty risk might arise in DeFi if the borrower fails to repay the loan.
To reduce this risk, large DeFi lending systems, such as Aave or Compound, generally require borrowers to over-collateralize their loans. However, some components of counterparty risk remain. For example, if oracles used in DeFi protocols fail, or if you deal in non-collateralized stablecoins (that lose their peg), your Lending/Borrowing position may suffer the consequences.
Smart contracts are programmable protocols that perform transactions when particular circumstances are satisfied. They are not, however, risk-free. Exploits into third-party services that protocols rely on, such as oracles (supplying off-chain data), pose one of the most serious risks.
Regardless on how well smart contracts are executed, their demand to collect more data points from outside partners allows attackers to alter that data and perform a hack on the DeFi protocol.
Impermanent loss occurs when you offer liquidity to a liquidity pool and the price of your deposited assets fluctuates from the time you placed them. The greater the magnitude of the shift, the more “temporary” loss.
Gas fees are payments made by users to compensate for the computational energy necessary to process and confirm blockchain transactions.
When the network is congested, gas prices might skyrocket. Heavy gas rates in the context of DeFi might arise during periods of heavy demand. Fees can fluctuate fast, increasing the costs for consumers.
Flash loans are a DeFi tool that allows users to borrow assets without requiring collateral. The loan must be returned in the same transaction. The transaction fails if it is not reimbursed, and no money is lost.
Flash loans, can be used by hackers. An attacker might get a flash loan, manipulate market prices to their benefit, and then repay the amount with a loss for the DeFi protocol.
While DeFi financing has various advantages, it also has certain drawbacks:
Despite these dangers, the DeFi industry is working hard to improve its usefulness, security, and scalability.
Nansen, a blockchain analytics platform, is a platform that can help with risk management. With real-time dashboards and notifications, this platform may assist investors in discovering opportunities, doing due diligence, and defending their investments. Look into DefiLlama for a free tool.
Before you begin, it's critical to understand how DeFi lending works. DeFi lending occurs on decentralized platforms, which means that the loan process is not managed by a centralized authority, such as a bank. Smart contracts, on the other hand, automate the loan and borrowing processes.
In order to utilize any DeFi platform, you must first create a cryptocurrency wallet. Wallets such as Metamask and Trust Wallet may be installed as browser extensions.
To lend on DeFi sites, you'll need cryptocurrency. You may buy it with ordinary currency on a cryptocurrency exchange or on Lympid.
Once you've created and funded your wallet with virtual assets, you may connect it to your preferred DeFi platform. This is normally accomplished by a few easy steps on the platform's website.
Once your wallet is linked, you may begin lending. This generally entails depositing your virtual assets into the smart contract of the platform. In exchange, you will begin receiving interest on your money.
Interest rates on DeFi platforms vary greatly, ranging from 0.5% to 693.8% depending on the platform. For example, on Aave, rates change dependent on supply and demand, with interest rates ranging from 0.5% to 82% for various cryptocurrencies.
Borrowers on these platforms can select between fixed and variable interest rates, which vary based on the protocol version utilized. There is no limit or minimum loan amount on Aave, and the liquidation barrier is normally around 80%, with an average 5% liquidation fee.
The particular collateral requirements change depending on the platform and currency. Before you begin lending, it is critical that you understand these requirements.
While promising, DeFi financing is not without hazards. Here are some suggested practices for reducing these risks:
Before you start lending, make sure to do your own research over the platform you're utilizing, the interest rates, and the collateral requirements.
Don't invest all of your money into a single platform or token. Diversification can aid in risk reduction.
DeFi platforms rely on smart contracts, which are susceptible to vulnerabilities or hackers. Be mindful of this danger and lend only what you can afford to lose.
On another hand, you can use onchain insurance covers.
The DeFi scene is rapidly evolving. Keep up to date on current developments in order to make the best loan selections.
The DeFi market was worth $13.61 billion in 2022, and it is predicted to increase at a 46.0% CAGR from 2023 to 2030. The removal of middlemen from financial processes, the user-friendly design and ease of use of DeFi platforms, and the integration of DeFi with diverse industries such as gambling and insurance are driving this expansion.
However, the industry faces a number of obstacles, including a lack of adequate infrastructure and regulations, as well as the possibility for large value reductions or liquidations during market downturns.
Furthermore, the COVID-19 epidemic has spurred the use of blockchain technology, particularly DeFi, because it simplifies and automates supply chain applications and corporate processes while also providing prospects for profit generating during a period of low interest rates. Blockchain technology, smart contracts, and data analytics in DeFi are major drivers to industry growth.
Based on these tendencies, the future of DeFi lending appears to be one of fast development and innovation. However, because of the possible hazards and problems involved with the emerging DeFi scenario, these developments will need to be continuously watched.
Real-world assets (RWAs) are gaining popularity in DeFi. Large DeFi lending platforms, such as MakerDAO, have begun investing in US Treasurys and corporate bonds, as well as partnering with traditional banks to make loans secured by RWAs.
This development is viewed as a big potential to connect traditional financial institutions with DeFi liquidity, as well as to provide practical use cases for DeFi that might disrupt the real-world assets sector and connect DeFi to the banking system.
Even under down market situations, stablecoins like Circle's USDC and Maker's DAI remain among the most frequently accepted cryptocurrencies. Japan, a country noted for its stringent cryptocurrency laws, said that the ban on domestic circulation of foreign-issued stablecoins would be lifted in 2023. This advancement might hasten the adoption of stablecoins and reduce the time and cost of international remittances.
The relevance of layer-2 scaling and zero-knowledge (ZK) technology is highlighted by Ethereum's next phase, called "the Surge" as well as continued concerns with gas prices and transaction speed. ZK proofs, a digital verification method, have the potential to greatly increase scalability and performance for blockchain networks, resulting in enhanced ecosystems that can handle more transactions in less time.
In the foreseeable future, security is projected to be a significant concern. ZK proofs can increase not just transaction speed and prices, but also the security of on-chain interactions. Following the theft of billions of dollars from DeFi systems in recent years, there is a major drive to improve security in the field in order to make it more appealing to a larger user base.
Despite regulatory ambiguity, Decentralized Autonomous Organizations (DAOs) have mainly avoided legal issues. The combination of their strong performance and structural maturity may result in a shift from centralized to decentralized institutions. This approach might improve transparency in decision-making in the space and help to avoid scenarios like the FTX collapse.
In conclusion, this article emphasizes DeFi lending's development as a transformational force in the financial world. It stresses the DeFi lending market's considerable growth and potential, which is being driven by the removal of intermediaries and the implementation of blockchain technology.
It also highlights the concerns of DeFi lending, including smart contract weaknesses, market volatility, temporary loss, variable gas fees, and flash loan hacks.
DeFi lending should be approached after extensive research, diversify the assets, be aware of smart contract dangers, and remain up to date on the growing DeFi ecosystem.
Here are some resources, platforms, and tools to assist you on better understanding and interacting with DeFi lending:
1. DeFi Pulse: DeFi Pulse is a website dedicated to tracking and analyzing the DeFi industry. It offers up-to-date metrics on the main DeFi protocols, making it an excellent resource for anybody interested in learning about the current condition of the DeFi market.
2. Decentralized Finance (DeFi): An Emerging Alternative Financial Architecture: This research paper gives an in-depth look at DeFi and its potential to transform financial systems. It's a must-read for anyone interested in the academic side of DeFi.
DeFi requires a grasp of the terms. Here are some useful glossaries:
1. Binance Academy's DeFi vocabulary: This comprehensive vocabulary covers a wide spectrum of DeFi and crypto topics.
2. CoinMarketCap's Crypto vocabulary: Another thorough vocabulary that contains both cryptocurrency-specific words and larger financial phrases.
Finally, here are a few platforms and resources to help you get started with DeFi lending:
1. Compound: Compound is a DeFi lending protocol that lets users earn interest on their digital assets.
2. Aave: Another DeFi lending site that gives interest on a number of cryptocurrencies is Aave.
3. Metamask: Metamask is a browser-based wallet popular for interacting with DeFi systems.
4. Zerion: Zerion is a DeFi investing interface that enables users to track and manage DeFi portfolios across several platforms.
Remember that, while these sites might give useful information and tools, it is critical to conduct your own research and understand the dangers before engaging in DeFi lending.