DeFi transforms credit routes on the blockchain

The world of decentralized finance (DeFi) is gradually expanding to encompass a significant portion of the global financial credit space due to its inherently trustless nature of operation and ease of access to capital. As the crypto ecosystem has grown into a $2 trillion industry by market cap, new products and offerings have emerged thanks to burgeoning innovation in blockchain technology.

Lending and borrowing has become an integral part of the crypto ecosystem, especially with the rise of DeFi. Lending and borrowing is one of the core offerings of the traditional financial system and most people are familiar with the terms in the form of mortgages, student loans and so on.

In traditional borrowing and lending, a lender makes a loan to a borrower and receives interest in exchange for assuming the risk, while the borrower provides assets such as real estate, jewelry, etc. as collateral to obtain the loan. Such a transaction in the traditional financial system is facilitated by financial institutions like a bank taking steps to minimize the risks involved in providing a loan by conducting background checks like Know Your Customer and credit checks before approving a loan.

Related: Liquidity has been driving DeFi’s growth so far, so what’s the outlook for the future?

Borrowing, Lending and Blockchain

In the blockchain ecosystem, lending and borrowing activities can be conducted in a decentralized manner, with the parties involved in a transaction being able to negotiate directly with each other without an intermediary or financial institution through smart contracts. Smart contracts are self-executing computer codes that have specific logic in which the rules of a transaction are embedded (encoded). These rules or loan terms can be fixed interest rates, the loan amount, or the contract expiration date, and are automatically executed when certain conditions are met.

Credit is obtained by providing crypto assets as collateral on a DeFi platform in exchange for other assets. Users can deposit their coins into a DeFi protocol smart contract and become a lender. In return, they receive native tokens for the protocol, such as B. cTokens for Compound, aTokens for Have or Dai for MakerDao, just to name a few. These tokens are representative of the amount of principal and amount of interest that can later be redeemed. Borrowers provide crypto assets as collateral in exchange for other crypto assets they wish to borrow from any of the DeFi protocols. Typically, the loans are over-collateralized to account for unexpected expenses and risks associated with decentralized finance.

Related: Do you want to take out a crypto loan? Here’s what you need to know

Loan, lending and total locked

One can lend and borrow across different platforms in the decentralized world, but one way to measure a protocol’s performance and choose the right one is to observe the total value locked (TVL) on such platforms. TVL is a measure of the assets staked in smart contracts and is a key indicator for evaluating the level of adoption of DeFi protocols, as the higher the TVL, the more secure the protocol becomes.

Smart contract platforms have become an important part of the crypto ecosystem, facilitating borrowing and lending due to the efficiencies offered in the form of lower transaction costs, higher execution speed, and faster settlement time. Ethereum is used as the dominant smart contract platform and is also the first blockchain to introduce smart contracts. TVL in DeFi protocols has grown by over 1,000% from just $18 billion in January 2021 to over $110 billion in May 2022.

Ethereum accounts for more than 50% of TVL at $114 billion, according to DefiLlama. Because of the first-mover advantage, many DeFi borrowing and lending protocols are built on top of Ethereum. But other blockchains like Terra, Solana, and Near Protocol have also gained traction due to certain advantages over Ethereum, such as lower fees, greater scalability, and more interoperability.

Ethereum DeFi protocols like Aave and Compound are some of the most well-known DeFi lending platforms. One protocol that has grown significantly over the past year is Anchor, which is based on the Terra blockchain. The main DeFi lending protocols based on TVL can be seen in the chart below.

The transparency that DeFi platforms offer is unmatched by any traditional financial institution and also allows for permissionless access, meaning any user with a crypto wallet can access services from any part of the world.

Nonetheless, the growth potential of the DeFi lending space is huge, and the use of Web3 crypto wallets further ensures that DeFi participants remain in control of their assets and have full control over their data due to the cryptographic security of the blockchain architecture .

This article does not contain any investment advice or recommendation. Every investment and trading move involves risk and readers should do their own research when making a decision.

The views, thoughts, and opinions expressed herein are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.