Things change in a blink of an eye in the crypto space. Decentralized Finance (DeFi) and DeFi loans are the current trends. It’s referred to as financial applications developed on blockchain technology using smart contracts.
Ethereum was the first to discover smart contracts, which is the core reason for using Ethereum blockchain for most DeFi applications. Since then, the world of DeFi has grown into a complete ecosystem of projects and protocols delivering substantial value to users. It gave traditional finance a new direction by enabling lending without needing an intermediary.
Popularly termed as ‘Open Finance’, decentralized lending enables cryptocurrency holders to earn annual yields by lending their assets. On the other hand, a borrower can take a loan through a decentralized platform, commonly known as lending protocols.
How DeFi Loans Work?
DeFi lending works through self-executing smart contracts. A lending protocol deploys a smart contract that serves as an automated digital intermediary and includes specific loan details, like repayment period, interest rate, etc. Anyone can become a lender and can maintain complete control over the funds at all times. This lender can send the tokens they wish to lend into lending protocols, also known as the money market.
Unlike traditional lending (like Nexo and Celcius), DeFi lending doesn’t require borrowers to go through rigorous procedures to prove their eligibility to get a loan. They just need cryptocurrencies, which they can use as collateral to take out a loan. Besides, both lenders and borrowers are free from KYC/AML procedures.
Centralized lending, on the other hand, mandates KYC procedures before offering any loan. Platforms like Nexo and Celsius offer great interest rates to lenders, but their daunting compliance processes make DeFi protocol a much better alternative for earning interest.
Top Protocols to Earn with DeFi Loans
Launched in 2018 by Rober Leshner, Compound Finance is a lending protocol built on the Ethereum network. It allows users to gain interest by lending out assets. Compound uses computer algorithms to create liquidity for cryptocurrencies through interest rates. The platform offers an interest rate of 3.53% on DAI, 0.26% on wrapped BTC, 0.19% on ETH, and 6.63% on USDC.
One of the earliest DeFi projects, MakerDAO is a unique DeFi crypto lending protocol that lends only DAI, a native token of the protocol. The platform allows fourteen different cryptocurrencies to use as collateral to borrow DAIs. With MakerDAO, lenders do not need to put their assets to create liquidity. Instead, borrowers are responsible for collateralizing their assets in Collateralized Debt Position (CDP) to get a loan. For 1 ETH, users can generate up to 834 DAIs at a collateralization ratio of 200%.
Aave is an open-source decentralized lending platform that allows lenders to deposit cryptocurrencies in a platform-supported pool. It allows users to receive aTokens (Aave’s native tokens) equivalent to the deposited assets. These tokens generate an interest fee that starts compounding algorithmically. Aave also adjusts the interest rate as per the demand and supply. Lending in Aave can generate a 14.99% interest rate on USDC, 0.11% on ETH, and 0.06% on wrapped BTC.
dYdX brought margin trading, futures, and derivatives to the DeFi space in addition to lending. Built on the Ethereum network, the platform does not have any lock-up period, meaning a lender can withdraw funds at any time. dYdX offers 9.33% interest rate on DAI, 0.01% on ETH, and 6.44% on USDC. Currently, the platform doesn’t support BTC or wrapped BTC.
Dharma protocol is a lending application launched on the Ethereum blockchain which facilitates the creation and trading of digital assets by tokenizing debt. The platform has Dharma Settlement Contracts that mimic the traditional process of lending. Dharma uses Dao as a stablecoin and dToken for protocol governance.
Beware When Earning with DeFi Loans
Like any other financial technology, DeFi lending has its share of limitations. The main risk for lenders is potential vulnerabilities within smart contracts. Though most of the projects run through auditing processes, they can still possess some risks. Hacks and “rug pull” scams are also increasing at an alarming rate.
In a nutshell, the risks will always exist. Therefore, the best course of action is to do significant research on security audits and the level of adoption before deciding on a lending protocol.
This is the last blog of our series on how you can start earning cryptocurrency on DeFi. I hope you enjoyed it.