What is Decentralized Lending & Borrowing
In traditional financial markets, if users want to obtain a loan, they need to go to a financial institution with significant liquidity (e.g., a bank) and provide qualifying collateral, such as the property rights of a house in the case of a mortgage. The user must regularly pay interest and a portion of the principal to the lender until the entire principal is paid off. In this market, liquidity generally comes from the financial institution's various deposits, financial bonds, etc.
In the DeFi market, where there are no traditional centralized financial institutions, all of this is executed by smart contracts. However, the logic of lending transactions in the cryptocurrency market is consistent with that in traditional markets: borrowers borrow crypto assets and pay interest, and lenders lend crypto assets to provide liquidity to earn interest.
Typically, borrowers are required to provide crypto assets as collateral in excess of the amount borrowed. Because the price of crypto assets is very volatile, it is possible for the value of the collateral to drop significantly or the value of the loan to increase significantly, making it insolvent. This makes risk control particularly important, and decentralized lending protocols often liquidate collateral before the user's collateral becomes insolvent.
Want to learn more about decentralized lending protocols in the DeFi market? Please refer to "What is Aave" chapter.
Compared with traditional financial lending, crypto lending has obvious flexibility. Borrowers can obtain loans without tedious KYC and credit due diligence checks. The specific use of the loan is not restricted, as in traditional markets, a mortgage can only be used to purchase the property rights for a house.
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