The world of decentralized finance (DeFi) is gradually expanding to encompass a significant part of the global financial lending space by virtue of the inherently trustworthy form of operation and ease of access to capital. As the cryptocurrency ecosystem has grown into a $2 trillion industry by market cap, new products and offerings have emerged thanks to burgeoning innovation in blockchain technology.
Loans and credits have become an integral part of the cryptocurrency ecosystem, especially with the advent of DeFi. Loans and credits are one of the main offerings of the traditional financial system, and most people are familiar with the terms in the form of mortgages, student loans, etc.
In traditional loans and credits, a lender makes a loan to a borrower and earns interest in exchange for assuming the risk, while the borrower puts up 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 such as a bank, which takes steps to minimize the risks associated with making a loan by conducting background checks such as “Know Your Customer” and credit scores. before a loan is approved.
Loans and blockchain
In the blockchain ecosystem, lending and borrowing activities can be carried out in a decentralized way, where the parties involved in a transaction can deal directly with each other without an intermediary or financial institution through smart contracts. Smart contracts are self-executing computer codes that have a certain logic in which the rules of a transaction are incorporated (encoded). These rules or loan conditions can be fixed interest rates, the amount of the loan or the expiration date of the contract and are executed automatically when certain conditions are met.
Loans are 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 exchange, they are issued tokens native to the protocol, such as cTokens for Compound, aTokens for Have, or Dai for MakerDao, to name a few. These tokens are representative of the capital and the amount of interest that can be redeemed later. Borrowers provide crypto assets as collateral in exchange for other crypto assets they wish to borrow from one of the DeFi protocols. Loans are typically overcollateralized to account for unexpected costs and risks associated with decentralized finance.
Loan, credit and total value locked
One can lend and borrow across various platforms in the decentralized world, but one way to gauge the performance of a protocol and select the right one is by looking at the total value locked (TVL) on those platforms. The TVL is a measure of the assets locked in smart contracts and is an important indicator used to assess the scale of adoption of DeFi protocols, as the higher the TVL, the more secure the protocol.
Smart contract platforms have become an important part of the cryptocurrency ecosystem and facilitate the granting of loans and credits due to the efficiencies they offer in the form of lower transaction cost, faster execution speed and settlement time. faster. Ethereum is used as the dominant smart contract platform and is also the first blockchain to introduce smart contracts. The TVL on DeFi protocols has grown by more than 1,000%, going from just $18 billion in January 2021 to over $110 billion in May 2022.
Ethereum occupies more than 50% of the TVL, with USD 114,000 million, according to DefiLlama. Many DeFi lending and credit protocols are built on top of Ethereum due to first-come advantage. However, other blockchains, such as Terra, Solana, and Near Protocol, have also gained traction due to certain advantages over Ethereum, such as lower fees, higher scalability, and more interoperability.
Ethereum DeFi protocols such as Aave and Compound are some of the most prominent DeFi lending platforms. But one protocol that has grown significantly in the last year is Anchor, which is based on the Terra blockchain. The main TVL-based DeFi lending protocols can be seen in the chart below.
The transparency offered by DeFi platforms is unmatched by any traditional financial institution and it also allows permissionless access, meaning that any user with a cryptocurrency wallet can access the services from anywhere in the world.
Nonetheless, the growth potential of the DeFi lending space is huge, and the use of Web3 cryptocurrency wallets further ensures that DeFi participants maintain control over their assets and have full control over their data by virtue of security. crypto provided by the blockchain architecture.
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Neeraj Khandelwal He is a co-founder of CoinDCX, an Indian cryptocurrency exchange. Neeraj believes that cryptocurrencies and blockchain can spark a revolution in the traditional financial space. His goal is to create products that make cryptocurrencies accessible and easy for the global public. His areas of expertise are in the cryptocurrency macro space, and he also has a keen eye for global cryptocurrency developments like CBDC and DeFi, among others. Neeraj has a degree in electrical engineering from the prestigious Indian Institute of Technology in Mumbai.
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