Automated DEFI borrowing and lending offer crypto users the two most fundamental banking services, earning interest on crypto deposits or paying interest to borrow crypto at interest, but crucially with the bank removed from the equation.
DEFI – decentralised finance – works on a purely Peer-to-Peer level. Users hold their assets in crypto wallets like MetaMask and interact directly with borrowing and lending protocols which function through Smart Contracts. There is no middleman, no central authority and the user retains custody of their funds.
Smart Contracts simply execute specific actions when criteria are met. For example, when this user deposits funds pay this amount of interest daily until funds are withdrawn.
The ‘decentralised’ element of DEFI comes from the fact that Smart Contracts are hosted on blockchains, like Ethereum, which operates across a distributed network of supporting Nodes with no one in ultimate control.
Decentralisation means DEFI protocols cannot arbitrarily restrict access to funds as can happen with traditional banks, but they are not without risks and disadvantages which are listed below.
DEFI Borrowing & Lending in numbers
At its peak in December 2021, there was over $250bn of total value locked in different DEFI applications, which is explosive growth considering that it didn’t really exist as a concept until 2018.
The bear market conditions of 2022 have seen this TVL number decline by more than 50% to around $75bn with the top two lending protocols as of June 15th 2022 – AAVE and Compound – accounting for almost $7.6bn or 10%. This decline will almost certainly continue as investors become more risk-averse.
The peak TVL numbers might seem impressive, but when compared to the global banking sector, valued at around $5trillion, you get a sense of the future potential for DEFI in general, and the core borrowing and lending functions.
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