DeFi Lending Structure

What is DeFi Lending

DeFi lending is a service where you deposit cryptocurrency through smart contracts to earn interest, or pledge collateral to borrow other cryptocurrencies. Unlike banks, there's no credit check, and anyone with collateral can get a loan instantly.

Depositors earn interest, and borrowers pledge collateral to borrow assets. The protocol acts as an intermediary, and all terms are transparently specified in code.

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Bank Loans vs DeFi Lending

Key Difference: DeFi uses an overcollateralized approach. You must pledge more collateral than the amount you borrow. The loan is secured by collateral, not credit.

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How Lending Protocols Work

Liquidity Pool Based

Banks take deposits and lend them out, but DeFi lending uses liquidity pools.

1. Depositors deposit assets into the pool
2. Borrowers pledge collateral and borrow from the pool
3. Interest paid by borrowers is distributed to depositors

Depositors and borrowers are not directly matched. The pool manages liquidity in between.

Interest Rate Determination (Utilization Model)

Interest rates are automatically determined based on pool utilization.

Utilization = Borrowed Amount / Total Deposited Amount

When utilization increases, interest rates surge to incentivize borrowers to repay and attract depositors. This mechanism maintains pool liquidity.

Kink Model

Most lending protocols use a "kink" model:

• Below 80% utilization: Gradual interest rate increase
• Above 80% utilization: Sharp interest rate increase (kink)

This maintains optimal utilization (70~80%) while preventing liquidity crises.

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Depositing (Supply/Deposit)

Deposit Process

1. Access lending protocol (Aave, Compound, etc.)
2. Select asset to deposit (ETH, USDC, etc.)
3. Enter amount and approve token
4. Execute "Supply" transaction
5. Receive interest-bearing tokens (aToken, cToken)

Interest Payment Methods

Rebasing Tokens (aToken - Aave):

• Interest reflected as token quantity increase
• Example: 1,000 aUSDC becomes 1,010 aUSDC over time

Interest-Accruing Tokens (cToken - Compound):

• Token quantity stays the same, value increases
• Example: 50 cUSDC (over time) has increased exchange rate, converts to more USDC

Deposit Interest Rate (APY)

Deposit interest rates fluctuate:

• High borrowing demand: APY rises
• Low borrowing demand: APY falls

Stablecoins (USDC, DAI) generally have the highest APY because borrowing demand is greatest.

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Borrowing

Borrowing Process

1. Deposit collateral (e.g., ETH)
2. Check available borrowing amount
3. Select asset to borrow (e.g., USDC)
4. Enter amount and execute "Borrow"
5. Receive asset, collateral remains locked in protocol

Collateral Ratio

Collateral ratio determines the maximum borrowing amount.

Max Borrow = Collateral Value x LTV (Loan-to-Value)

Example (ETH LTV 80%):

• Collateral: 1 ETH ($3,000)
• Max Borrow: $3,000 x 80% = $2,400

LTV Examples (Aave V3):

More volatile assets have lower LTV.

Why Borrow?

If you're pledging ETH as collateral to borrow USDC, why not just sell the ETH?

Reasons to Borrow in DeFi:

1. Tax Deferral: Selling ETH is a taxable event. Borrowing is not.
2. Maintain Long Position: Stay exposed to ETH upside while obtaining cash
3. Leverage: Buy more ETH with borrowed USDC (looping)
4. Yield Farming Capital: Pursue higher yields in other DeFi protocols
5. Payments/Expenses: Spend without selling holdings

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Major Lending Protocols

Aave

Features:

• Largest TVL lending protocol
• Multi-chain support (Ethereum, Arbitrum, Polygon, etc.)
• Flash loan functionality
• Variable/fixed interest rate options
• GHO stablecoin issuance

Tokens:

• aToken: Deposit receipt (aUSDC, aETH, etc.)
• AAVE: Governance token

Compound

Features:

• Pioneer of DeFi lending
• Simple and proven structure
• Compound III (Comet): Single asset market structure

Tokens:

• cToken: Deposit receipt (cUSDC, cETH, etc.)
• COMP: Governance token

Other Protocols

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Interest Rate Types

Variable Rate

Fluctuates in real-time based on borrowing demand

• Pros: Generally lower rates
• Cons: Unpredictable, can spike

Fixed Rate (Stable Rate)

Fixed rate for a certain period (offered by Aave)

• Pros: Predictable costs
• Cons: Higher than variable rates

Fixed rates can also be rebalanced in extreme market conditions.

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Risks

Liquidation Risk

If collateral value drops, you can be liquidated. This is the biggest risk for borrowing positions.

Interest Rate Risk

Sudden interest rate spikes can make borrowing costs higher than expected. During liquidity crises, rates can soar to hundreds of percent.

Smart Contract Risk

Protocol bugs can result in loss of deposited assets. Verified protocols (Aave, Compound) are relatively safe, but not 100%.

Oracle Risk

If price feeds (oracles) are wrong, unfair liquidations or exploits can occur.

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Practical Tips

For Depositors

• Stablecoin deposits are most stable: Interest earnings without price fluctuation
• APY fluctuates, so check periodically
• Diversify deposits across multiple protocols to spread risk

For Borrowers

• Monitor health factor: Prevent liquidation
• Maintain conservative collateral ratio: Only borrow 50~60% of LTV
• Consider gas fees: Frequent adjustments incur costs
• Plan for repayment: Interest accumulates

For Beginners

• Start with small amounts
• Gain experience with stablecoin deposits
• Only borrow after fully understanding the mechanism

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Summary

DeFi lending operates on an overcollateralized basis, forming efficient capital markets through liquidity pools and algorithmic interest rates. Depositors earn interest, and borrowers pledge collateral to borrow assets. Aave and Compound are representative protocols, and you should be mindful of liquidation risk and interest rate fluctuations. It can be used for various purposes including tax deferral, leverage, and capital acquisition.

Next article: Collateral and Liquidation - Core Mechanisms of DeFi Loans