What is DeFi lending?

As the price of most major cryptocurrencies (BTC, ETH, DOT) have clearly been on a reliable uptrend these past couple of years, investors are increasingly realising that spending their crypto might not be a good strategy in the long run. But cryptocurrencies are currencies, so understandably some investors wish to be able to unlock the fiat value of their crypto funds and spend it on real-world goods and services. This is where decentralised lending in the form of crypto loans come into play. 

The DeFi ecosystem enables certain crypto investors (borrowers) to obtain spending capital without having to part with even a fraction of their precious digital assets. Other investors (lenders) choose to lock up their crypto and let it earn passive income (yield) in the form of interest on stablecoin loans they issue to the borrowers.  The process is quite similar to fiat currency lending by legacy banks, only without the need of a middleman (the bank). 

How does it work?

Made popular by the Ethereum blockchain, smart contract protocols play the role of the third-party arbiter in each transaction between the lender and the borrower. In addition, they automatically pay out interest on all cryptocurrency deposits from the margin generated through the loan issuance. Sounds complicated at first, but the process is very straightforward:

First, both the lender and the borrower have to agree to the terms of the loan. As soon as the terms are met, the smart contract immediately executes the transaction. For example, the smart contract algorithm might check if the borrower has put down sufficient digital collateral for the loan before transferring the funds (usually fiat-pegged stablecoins) from the lender’s wallet to the borrower’s wallet. Upon repayment of the loan, the collateral is automatically released back to the borrower. Since the third-party arbiter in this whole process isn’t actually a living, breathing person but an algorithm, the whole transaction process requires very minimal fees. This results in much greater returns for both parties, especially compared to any legacy bank-issued loans. 

The evolution of DeFi lending 

Let’s take a look at how decentralised lending has evolved by taking a close look at the three major DeFi lending platforms.

MakerDAO

One of the earliest and most successful DeFi protocols, MakerDAO offers its own crypto stablecoin called DAI. Utilising smart contracts, lenders can lock up their crypto assets into “vaults” and receive DAI, which are pegged 1:1 to the U.S. dollar. This enables borrowers to easily convert their freshly received DAI loan to actual USD whenever they want to buy something in the real world. If they wish to get their crypto assets back, they must redeposit the amount of DAI they borrowed plus a little bit of interest. 

Compound Finance

A more advanced DeFi platform, Compound is an autonomous lending pool where users can lend a wide range of stablecoins to other users who put down collateral in the form of crypto assets. Of course, the collateral must be worth more than the total value of the loan they wish to take out. When they receive a loan, they start paying interest on it. Borrowers get reunited with their crypto collateral as soon as they repay the loan plus interest. All interest they’ve been paying then goes back into the pool to pay the investors. While Compound offers great rates, the only drawback is that the rates can sometimes fluctuate unexpectedly based on supply and demand. This particular annoyance is easily solved however by newer DeFi lending platforms. Platforms just like…

Yearn.finance

Launched in mid-2020, this DeFi platform allows lenders to select the amount of stablecoins they wish to lend out and let the system allocate these funds to wherever the best interest rates are offered at any given time. This way, users do not have to manually figure out where the optimal returns are today, tomorrow or next week. As soon as the Yearn protocol detects that a particular lending platform offers higher rates, it automatically sends stablecoin funds to that particular lending pool. Yearn is truly a new breed of blockchain platform that demonstrates the innovative ways that DeFi “money legos” can work to optimise investor gains.

Earning additional interest through Phuture and Yearn.finance

Naturally, we at Phuture are taking full advantage of Yearn.finance’s pioneering DeFi protocol. As you already know, each Phuture index product is backed by varying quantities of crypto assets. Instead of leaving this capital sitting idle and earning no extra income, we lend out some of it on Yearn.finance, where it’s constantly earning the highest interest rate possible. As a result, Phuture index investors receive the additional income generated from our lending activities, which helps to improve their overall return. Are you a Phuture investor yet?