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What Are Lending Protocols And How Do They Work?

Decentralized finance (DeFi) is one of the most recent innovations in the cryptocurrency space. Since it provides various services to numerous market players, including crypto investors, we will touch base on lending as a critical aspect of DeFi below. Let’s begin.

Understanding Defi And Lending Protocols

Decentralized Finance uses blockchain technology to power an entire ecosystem of financial applications and operates without a central authority. Instead of using such an authority, DeFi uses a peer-to-peer network to set up decentralized applications, allowing users to manage their assets anytime and anywhere. 

This ecosystem relies on self-executing smart contracts to provide permissionless, transparent, and open-source financial services worldwide. The DeFi ecosystem originated on the Ethereum network, meaning that most DeFi protocols exist on this crypto blockchain.  

DeFi Lending

Lending protocols or platforms makes it possible to lend crypto assets for various purposes. This option allows crypto holders to stake the coins they own specifically for lending purposes. The lending process takes place without third parties from start to finish through smart contracts. 

For instance, if a borrower takes out a crypto loan on the DeFi platform, the lender earns interest once the loan is returned. This process works as follows: 

  • A coin holder utilizes a smart contract to send their intended lending tokens into a pool;
  • Once this step is completed, the coins become available for other individuals to borrow;
  • Next, the smart contract issues tokens (typically the native token of the platform);
  • These tokens automatically go to the lender;
  • Loans issued through native tokens require borrowers to provide a guarantee ;(collateral).

Here is a graphic representation of the differences between DeFi lending and traditional lending:

Image Source: leewayhertz.com

Most Popular DeFi Lending Protocols

If you’re looking to learn more about the DeFi ecosystem, several lending protocols have a proven track record of ease of use and reliability. The list includes:

  • AAVE
  • Uniswap
  • YEarn
  • Kyber Network
  • Balancer

AAVE

AAVE is one of the leading and most popular lending protocols in the DeFi landscape. One of its most significant advantages is that its native token, AAVE, enables users to participate in its governance and provides security for the protocol. You can achieve AAVE rewards by staking AAVE tokens through the Safety Module.

UniSwap

UniSwap protocol is one of the most popular decentralized exchanges in the DeFi space and is also among the leading protocols. You can earn its native token, UNI, by offering liquidity to certain pools. 

YEarn

This automated liquidity aggregator deserves to be mentioned as the top choice among famous DeFi protocols. It offers several options for yield farming, and the protocol’s governance is in the hands of YEarn’s native token, YFI. Users can claim a pro-rata share of the protocol fees by staking YFI tokens while participating in protocol governance.

Kyber Network

When it comes to capturing value through native tokens, the Kyber Network is another excellent example of highly functional decentralized exchanges. Kyber Network’s native tokens are known as KNC (Kyber Network Crystals), and token owners can leverage their ownership to gain delegation and voting rights over crucial protocol decisions (like introducing governance mechanisms, for instance).

Balancer

Most lists tackling popular DeFi protocols state Balancer in one form or another. Balancer DeFi users can benefit from governance coupled with automated liquidity and asset management through its native token, BAL. Owning BAL tokens allows users to participate in governing supporting assets protocol fees and other crucial protocol aspects.  

Disclaimer: For information purposes only. Not investment or financial advice. Seek professional advice. Digital assets involve risk. Do your own research.

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