Beginner's Guide to Understanding DeFi Lending and Borrowing
Written by  Daisie Team
Published on 9 min read


  1. What is DeFi?
  2. How DeFi lending works
  3. How DeFi borrowing works
  4. Benefits of DeFi lending and borrowing
  5. Risks of DeFi lending and borrowing
  6. Popular DeFi lending and borrowing platforms
  7. How to participate in DeFi lending
  8. How to participate in DeFi borrowing
  9. Why interest rates matter in DeFi
  10. Final thoughts on DeFi lending and borrowing

Are you curious about the world of decentralized finance? Perhaps you've heard the terms 'DeFi lending' and 'DeFi borrowing' and wondered what they mean? Well, you're in the right place to find out! We're going to make understanding DeFi lending and borrowing as easy as pie. So, sit back, relax, and let's dive into the fascinating world of DeFi.

What is DeFi?

DeFi, short for Decentralized Finance, is a revolutionary concept that aims to reinvent the traditional financial system. It's like your local bank, but with a major twist: there's no actual bank! Or any other middleman, for that matter. Instead, DeFi applications run on blockchain — a digital ledger that's open to everyone and controlled by no one.

So, how does it work? Well, imagine if you could cut out the bank from your financial transactions. That's DeFi for you. It's all about peer-to-peer interactions. You lend, you borrow, you earn interest, and you pay interest — all directly with other users, just like you.

Now, let's dig a little deeper. Here are a few key aspects of DeFi:

  • Smart Contracts: These are the backbone of DeFi. A smart contract is a self-executing contract with the terms of the agreement directly written into code. They automate transactions and make sure everything goes smoothly without the need for intermediaries.
  • Decentralized: This means there's no central authority or middleman. All transactions happen directly between peers.
  • Open to Everyone: Anyone, anywhere, can participate in DeFi. All you need is an internet connection and a digital wallet to start understanding DeFi lending and borrowing.

In the next sections, we'll get into the nitty-gritty of how DeFi lending and borrowing work, their benefits, risks, and how you can get involved. So, stick around! It's going to be an enlightening ride.

How DeFi lending works

So, how does this DeFi lending thing work? Well, it's not as complicated as it might sound.

Think of DeFi lending like a virtual savings account. You deposit your digital assets into a DeFi platform, and in return, you earn interest. But here's the kicker: the interest rates are usually much higher than what traditional banks offer.

Here's a simple step-by-step explanation:

  1. You Deposit Your Digital Assets: To start, you deposit your digital assets (like cryptocurrencies) into a DeFi lending platform. This is similar to how you'd deposit money into a savings account at a bank.
  2. Your Assets are Pooled: Your assets are then pooled together with other users' assets. This pool of funds is then available for other users to borrow.
  3. You Earn Interest: As users borrow from the pool, they pay interest. This interest is then distributed back to you and the other lenders in the pool.

Now, you might be wondering: "Why would I loan out my hard-earned digital assets?" Well, the answer is simple: to earn passive income. By lending your assets, you're able to earn a steady stream of income through interest payments. And that's the beauty of understanding DeFi lending and borrowing - it opens up new avenues for you to grow your wealth.

So, how about we take a look at the other side of the coin? Let's talk about how DeFi borrowing works next.

How DeFi borrowing works

Now, let's switch gears and talk about DeFi borrowing. After all, understanding DeFi lending and borrowing means looking at both sides of the equation. OK, so how does borrowing work in this DeFi world? Well, let's break it down.

Just as you might take a loan from a bank, in DeFi, you can borrow digital assets. However, DeFi borrowing operates slightly differently. Remember, there are no physical locations, no loan officers, and no lengthy paper applications. Everything happens online, through smart contracts.

  1. You Provide Collateral: To start borrowing, you first need to provide collateral. Your collateral, often in the form of other digital assets, acts as a security deposit. It’s a guarantee that you'll repay what you borrow.
  2. You Borrow Digital Assets: Once your collateral is accepted, you can borrow digital assets up to a certain percentage of your collateral's value.
  3. You Repay the Loan: Over time, you repay the borrowed amount plus interest. If you fail to repay, your collateral is used to cover the debt.

So, why borrow in DeFi? One reason might be to gain more capital to invest without selling your existing assets. For example, you might believe Bitcoin's price will go up. Instead of selling your Bitcoin, you can use it as collateral to borrow funds and invest in other digital assets.

Again, the key to understanding DeFi lending and borrowing is to see it as a two-sided coin. As we've seen, both sides can offer opportunities to grow your wealth in the digital asset space. But, as with any financial system, there are also risks and benefits to consider, which we'll explore in the next sections.

Benefits of DeFi lending and borrowing

Now that we've covered the basics of how DeFi lending and borrowing works, let's delve into the benefits. Why should you even consider diving into this world? Here's why:

  1. Open to Everyone: Traditional finance often leaves out many people around the world. With DeFi, as long as you have internet access, you can participate. It's a more inclusive financial system.
  2. Control Over Your Assets: In DeFi, you hold the keys to your assets, not a bank. This gives you more control and access to your money anytime, anywhere.
  3. Opportunity for High Returns: Unlike the minimal interest rates offered by traditional banks, DeFi platforms can offer significantly higher returns.
  4. Transparency: DeFi operates on blockchain technology, which is open for everyone to see. So, you can verify transactions and contracts for yourself.

These are just some of the benefits that contribute to the appeal of DeFi lending and borrowing. But remember, with greater rewards also comes greater risks. The world of DeFi is still relatively new and can be volatile. So, it's crucial to understand both the opportunities and the risks before you dive in.

Risks of DeFi lending and borrowing

While understanding DeFi lending and borrowing opens up a world of opportunities, it's not without its risks. Here are a few you should be aware of:

  1. Smart Contract Vulnerabilities: DeFi relies on smart contracts to manage transactions. However, these contracts, while intricate and powerful, are not foolproof. They can contain bugs or vulnerabilities which could be exploited, leading to loss of funds.
  2. Price Volatility: Cryptocurrencies, the backbone of DeFi, are known for their price volatility. Sudden swings can impact the value of your collateral or loans.
  3. Regulatory Uncertainty: DeFi is still a new and rapidly evolving sector. The regulatory environment is unclear in many regions, which could lead to abrupt changes impacting your DeFi activities.
  4. Liquidity Risks: While DeFi platforms can offer high returns, there's a risk that you may not be able to withdraw your assets due to a lack of liquidity. This is especially true during periods of intense market volatility.

While these risks might seem daunting, don't let them scare you off just yet. Understanding DeFi lending and borrowing means being aware of both its potential rewards and risks. Being informed helps you make calculated decisions and navigate the DeFi landscape with confidence.

Now that you have a beginner's understanding of DeFi lending and borrowing, let's explore some popular platforms where you can get started. Each of these platforms has its own unique features, but they all share the common goal of making financial services more accessible and efficient.

  1. Compound: This is a decentralized protocol built on the Ethereum blockchain. Users can lend and borrow a variety of cryptocurrencies. The interest rates are algorithmically determined based on supply and demand.
  2. Aave: Aave is another Ethereum-based platform which stands out with its range of features, such as flash loans which require no collateral.
  3. MakerDAO: MakerDAO allows users to lock up collateral and generate DAI, a stablecoin pegged to the US dollar. This is a unique way to borrow in the DeFi space.
  4. Uniswap: Uniswap is a decentralized exchange where you can lend your assets to liquidity pools. In return, you earn fees from the trades that occur in the pool.

These platforms provide a snapshot of the diversity in the DeFi lending and borrowing sector. Remember, it's important to do your own research before diving in. Understanding DeFi lending and borrowing isn't just about knowing how it works, but also where to participate.

How to participate in DeFi lending

So, you're interested in joining the DeFi revolution and want to lend your assets. But how exactly do you go about it? Here's a simple breakdown of the steps you'd usually follow:

  1. Choose a Platform: We've already covered some popular DeFi platforms. Choose one that best suits your needs and preferences.
  2. Create a Wallet: You'll need a digital wallet compatible with the platform. Wallets like MetaMask, Trust Wallet or Coinbase Wallet are widely used.
  3. Buy Cryptocurrency: You need to have some cryptocurrency to lend. This can be purchased on an exchange like Coinbase, Binance or Kraken, and then transferred to your wallet.
  4. Connect Your Wallet to the Platform: Once you have your cryptocurrency in your wallet, connect your wallet to the DeFi platform.
  5. Deposit Funds: You can now deposit the cryptocurrency you wish to lend on the platform. Make sure you understand the terms and conditions of the lending contract.

And there you have it! You are now part of the DeFi ecosystem, earning passive income from lending your assets. Keep in mind, understanding DeFi lending and borrowing also means understanding the risks involved, which we will cover in the next section.

How to participate in DeFi borrowing

So, now that you're familiar with lending, let's switch gears and talk about borrowing. Here's a step-by-step guide on how you can participate in DeFi borrowing:

  1. Pick Your Platform: Just like with lending, your first step is to choose a DeFi platform that aligns with your needs. Remember, different platforms may offer different borrowing terms and interest rates.
  2. Set Up Your Wallet: If you haven't done so already, you'll need to create a digital wallet. MetaMask, Trust Wallet, and Coinbase Wallet are a few popular options.
  3. Provide Collateral: DeFi borrowing requires collateral. You'll need to deposit cryptocurrency into your wallet to secure your loan. This could be Ether (ETH), DAI, or another accepted token.
  4. Connect Your Wallet and Borrow: After connecting your wallet to the DeFi platform, you can borrow funds against your collateral. Your borrowing limit will be based on the value of your collateral.
  5. Manage Your Loan: Keep an eye on your loan and its associated interest rate. You'll need to repay the loan and any accrued interest to regain full access to your collateral.

And just like that, you've taken your first steps into the world of DeFi borrowing! It's important to keep in mind that understanding DeFi lending and borrowing isn’t a one-time thing. The DeFi landscape is constantly changing, and staying informed is key to making the most of your lending and borrowing activities.

Why interest rates matter in DeFi

Let's talk about interest rates. You might be thinking, "Why do I need to worry about these numbers?" Well, interest rates are a big deal when it comes to DeFi. They're like the pulse of the DeFi world: they can tell you a lot about what's going on.

Firstly, interest rates are the cost of borrowing. When you borrow funds in DeFi, you're expected to pay back more than you borrowed. That "extra" is the interest. The rate at which this interest accrues can significantly affect your DeFi experience. If the rate is high, you’ll end up owing a lot more. On the other hand, if the rate is low, your loan becomes cheaper.

Secondly, interest rates are also the reward for lending. When you lend your crypto assets, you earn interest. The higher the rate, the more you earn. So, a high interest rate isn't all bad—it's great when you're on the lending side of things!

Finally, interest rates can indicate the health of the DeFi market. High rates could mean there's a high demand for borrowing, while low rates could suggest the opposite. By keeping an eye on interest rates, you can gain insights into market trends and make informed decisions.

Understanding DeFi lending and borrowing also means understanding the role of interest rates. So, don't overlook them. They might just be numbers, but in DeFi, these numbers matter—a lot.

Final thoughts on DeFi lending and borrowing

So, now you've dipped your toes into the world of DeFi lending and borrowing. It's pretty cool, isn't it? It's like being part of a financial revolution—a revolution that's taking power from the big banks and giving it back to everyday people like you and me.

DeFi lending and borrowing can be a great way to earn interest or access funds without selling your crypto assets. Plus, it's all done on the blockchain, which means it's transparent, secure, and open to everyone, no matter where you are in the world.

But remember, it's not all sunshine and rainbows. Like anything else in life, there are risks. The crypto market can be volatile, and there's always the chance of losing your investment. So, always do your homework, stay informed, and never invest more than you can afford to lose.

If you go into it with open eyes and a cautious mindset, understanding DeFi lending and borrowing can open up a world of opportunities. After all, knowledge is power. And in the world of DeFi, that power is in your hands.

So, are you ready to take the plunge into DeFi? It's a brave new world out there, and it's waiting for you to explore it. Happy lending and borrowing!

If you're eager to learn more about DeFi lending and borrowing, don't miss the workshop 'Start Your web3 Journey' by Tom Glendinning. This workshop will provide you with a comprehensive understanding of web3, a key element of the decentralized finance ecosystem, and help you navigate the world of DeFi with confidence.