DeFi lending and borrowing is still a relatively new phenomenon in the financial sector. And yet, it already beats CeFi solutions in many aspects.
The total value locked in DeFi has immensely grown during the last bullrun. With its current evaluation hovering around an astonishing sum of 60 billion USD, the overall interest in this technology will surely grow in time.
In this article, we are going to take a closer look at how DeFi lending and borrowing works, what benefits and dangers it bears, and what Liquid Loans does in order to alleviate these risks
Decentralized finance (DeFi) combines a whole ecosystem of blockchain-based financial applications under its hood.
With the help of smart contracts and other innovative tools and features, it enables users to connect with each other on a peer-to-peer basis and manage their own assets in a self-custodial manner without having to rely on any third party.
DeFi lending and borrowing, in turn, is a set of services offering crypto loans in a trustless form.
With the help of appropriate protocols and platforms, borrowers can take loans with a few clicks of a mouse as they don’t have to submit any documents or even provide an ideal credit score.
At the same time, cryptocurrency holders can safely lend their assets and earn passive income on their investments.
In contrast to DeFi, Centralized Finance (CeFi) always implies a custodian to hold and manage users’ assets. Thus, centralized exchanges (CEXes) as the most popular example of such services route all transactions through the servers controlled only by these platforms.
In many aspects, CeFi services act very similarly to traditional banks and other centralized financial institutions.
They trade their reputation in exchange for the users’ trust and assets. At the same time, they take all the pains of providing funds’ security and managing users’ assets.
Yet, despite all these conveniences, the popularity of DeFi lending and borrowing keeps growing. Why does it happen?
CeFi services failing their customers is not a novelty in the crypto world. FTX crash and other centralized crypto services failures that took place in 2022 are still fresh in the memory of cryptocurrency users. Thus, storing your funds on centralized platforms as well as using their lending services becomes questionable.
DeFi lending and borrowing services, on the contrary, are capable of solving many of the issues inherent to centralized solutions. Here are some of the key benefits that this approach provides:
- Transparency. Not all of the DeFi applications feature open-source code. Yet, unlike CeFi solutions, most of the transactions executed on such platforms are registered on a public blockchain. This makes them fully transparent and verifiable.
- Self custody. In contrast to CeFi, many DeFi lending and borrowing services enable users to store and use their funds on self-custodial wallets. Thus, users can be sure that no one will ever be able to block their wallets as they control their private keys.
- Accessibility. One can hardly find a CEX or a stock exchange that serves all the customers worldwide regardless of geography. Decentralized solutions, on the contrary, impose no limitations as they are accessible to all users worldwide.
- Flexible rates. DeFi lending and borrowing services offer much better rates to all the participants of the process. Lenders may get much better returns on their investment in comparison with traditional savings accounts. Borrowers, on the contrary, can enjoy loan rates lower than in traditional banks.
The advantages of the new approach are indisputable. Yet, there are also some negative aspects that one should consider as well.
- Liquidations. If the value of the collateral that borrowers provide falls below a predefined limit, the position may be automatically liquidated while borrowers will bear losses.
- Impermanent loss. Lenders may also face significant losses due to the high volatility of the crypto market unless they contribute stable assets to liquidity pools.
- Execution order malleability. With public permissionless blockchains, users openly share the information about transactions they intend to perform. Evil actors may use this information for their own benefit. They may influence transaction execution order by raising transaction fees and using other ways to manipulate the market.
- Flash loan attacks. What’s more, DeFi lending and borrowing services serve as an ideal tool for flash loan attacks. Hackers may exploit vulnerabilities in smart contracts and use the funds they get via flash loans to manipulate market prices.
- The lack of regulatory framework. DeFi lending and borrowing still don’t fall under any clear regulations. Thus, using such services puts you at risk of governmental scrutiny and potential fines.
When developing its DeFi lending and borrowing protocol, Liquid Loans keeps in mind these problems. With its help, users can benefit from interest-free loans which are more capital-efficient than other systems as they require less collateral to back the loan.
Here are some of the key technological aspects that it relies on:
- Stability Pool and Liquidations. This is a smart contract full of $USDL which helps users reduce their losses in the case of liquidation. If a certain vault gets liquidated, the Stability Pool cancels and absorbs its debt.
- Minimum collateral. To borrow a stablecoin $USDL, one has to deposit some amount of $PLS into the vault first. After that, it’s possible to withdraw $USDL up to a collateral ratio of 110%.
- Redemption mechanism. This function enables users to get $USDL and redeem it for $PLS at any time by providing the hard peg for its stablecoin.
Besides, Liquid Loans builds its product on a fully trustless, immutable, and permissionless blockchain which helps to maintain the network secure and protect it against any external influence.