In traditional finance secured loans generally use an illiquid asset (like a house) – something which isn’t easy to sell quickly – to borrow a liquid asset, like money. In the crypto version of a secured loan, one liquid asset is used to borrow a different liquid asset, so what’s the point?
There are plenty of scenarios in which it makes sense to use crypto A as collateral to borrow crypto B:
- You need short-term cash for a deposit on a new house or car, but don’t want to sell crypto A and lose out on the long-term appreciation
- You want to sell crypto but avoid capital gains tax so borrow a Stablecoin and convert that to fiat which doesn’t count as a taxable disposal
- You want to borrow a Stablecoin in order to yield-farm, or trade, generating returns that you anticipate to be greater than the interest rate on the loan
Examples of DEFI lending providers
AAVE and Compound are two of the biggest DEFI borrowing and lending providers.
AAVE offers borrowing and lending across a number of different blockchains including Ethereum, Avalanche and Polygon. AAVE boasts the largest amount of TVL of any lending provider according to Defillama with roughly $4.9bn in deposited assets and $2bn in loans at the time of writing.
AAVE has its own governance token, of the same name, paid as an additional reward to protocol users, which reached an All-Time High of $667 in May 2021 but has declined over 90% since.
Compound is an Ethereum-specific lending protocol listed as second in terms of TVL behind AAVE with around $2.7bn of deposits and $1bn in loans.
Compound has its own governance token, COMP, paid as an additional reward to protocol users, which reached an All-Time High of $911 in May 2021 but as with AAVE’s token has declined by 90% as overall crypto markets have entered a bear market.
1.139 COMP are distributed to users on a daily basis in proportion to their activity. This will continue until the COMP supply cap is reached or there is a governance vote to change this.
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