Foreword

Borrow/Lend is one of the most basic and core functions in the financial field. Through borrowing and lending, people can borrow funds at a certain interest rate when funds are insufficient, or lend them to others to earn interest when funds are surplus. For the blockchain industry, borrowing and lending is equally important. With the help of smart contracts and decentralized trading platforms, the lending model on the blockchain provides users with global, borderless financial services and reduces the entry barrier to a certain extent.

In recent years, decentralized finance (DeFi) has rapidly emerged, various lending platforms have emerged, and many functional tokens, such as AAVE, COMP, MKR, etc., have also been created. Through this article, you will learn about the differences between traditional financial lending and blockchain lending, the working principles and investment risk points of mainstream blockchain lending platforms, and the possible development directions of the entire lending ecology in the future.

1. The basic concept and operation mode of lending

1.1 The Essence of Borrowing

\
The essence of lending is the matching of funds between the fund provider (lender) and the demand party (borrower). In order to obtain temporary access to funds, borrowers need to pay interest, while lenders use their idle funds to earn profits. In the traditional financial system, this matching is often accomplished through centralized institutions such as banks and loan companies. However, blockchain lending platforms utilize smart contracts to achieve automatic matching and clearing, eliminating the need for intermediary banks or institutions, to some extent reducing intermediary fees and review processes.

1.2 Typical Operation Mode: Collateralized Borrowing

\
In the field of blockchain, the mainstream lending model is usually over-collateralized lending. Borrowers need to collateralize high-value digital assets (such as ETH, BTC, or other tokens accepted by the platform) into the platform’s smart contract, and then borrow a certain amount of stablecoins or other tokens based on the collateral ratio. Due to price fluctuations, the system sets collateral ratios and liquidation mechanisms to ensure the overall fund security of the lending platform. If the value of the collateral drops below a certain threshold, the system will automatically liquidate the collateral to repay the lenders.

Formation of 1.3 interest rates

\
Whether it is traditional or blockchain lending, interest rates are usually determined by the supply and demand of funds. In DeFi lending platforms, smart contracts dynamically adjust borrowing and deposit interest rates based on the supply and demand of assets in the liquidity pool. When more people want to lend a certain asset, the borrowing interest rate for that asset will increase to attract more lenders to deposit assets into the platform. Similarly, if the supply of funds is large and the demand is insufficient, the borrowing interest rate will decrease to encourage more people to borrow funds.

2. TradFi lending VS blockchain lending

2.1 Fund Intermediary and Review Mechanism

• Traditional lending: relying on banks or loan institutions, they conduct identity verification, credit review, income assessment and other examinations on borrowers, decide whether to lend and determine interest rates.
• Blockchain lending: Mainly based on the value of smart contracts and collateral assets, it often does not require identity verification and credit scoring. Relatively speaking, the over-collateralization model reduces the requirements for borrower’s credit, but at the same time, the capital utilization rate will be reduced due to the need for over-collateralization.

2.2 Efficiency and Convenience \

• Traditional Lending: The lending process is complex and time-consuming, and the offline approval process may take several days to several weeks.
• Blockchain lending: No need for manual approval, automatic execution with smart contracts, and usually the loan application can be completed in real time. However, network congestion or high gas fees in the blockchain may also affect the cost and speed of lending transactions.

2.3 Risk and Regulation

• Traditional lending: Lenders and borrowers are legally protected under the strict supervision of financial regulatory authorities in various countries, but the regulatory system may also limit innovation.
• Blockchain lending: Currently in a rapid development stage, some platforms lack sound regulatory systems and operate in a regulatory gray area. Risks such as contract security vulnerabilities, hacker attacks, and market volatility are worth paying attention to.

3. Introduction to Lending Platforms and Typical Projects

In the field of blockchain, many decentralized lending platforms have emerged. They each have their own unique features in terms of functional design, contract deployment, and token economic models. The following introduces several representative projects.

3.1 Aave

• Platform Introduction: Aave was initially launched as ETHLend and later developed into a well-known lending protocol on the Ethereum network.
• Featured Function: Introducing ‘Flash Loans’, which allows users to borrow funds without collateral in a single transaction and quickly repay them, used for arbitrage, collateral switching, or other complex operations.
• Platform token: AAVE Token. AAVE holders can participate in protocol governance and receive a portion of platform revenue distribution.

Source:Aave official information

3.2 Compound

• Platform introduction: Compound is one of the early lending protocols in the Ethereum ecosystem. Users can earn interest by depositing encrypted assets into the Compound pool, and can also borrow assets from the pool.
• Platform token: COMP Token. COMP is used for community governance, and holders can vote on the protocol interest rate model, collateral asset list, and other parameters.

Source:Compound Official Information

3.3 MakerDAO

• Platform Introduction: MakerDAO is the core protocol of decentralized stablecoin DAI. It mints DAI by collateralizing assets such as ETH, allowing users to obtain stable liquidity while holding exposure to encrypted assets.
• Platform Token: MKR Token. Used for governance voting to determine key parameters such as collateral ratio, interest rate, etc.
• Features: Compared to other lending platforms, MakerDAO focuses more on the issuance of stablecoins and collateral mechanisms, extending its functionality to the construction of decentralized stablecoins.

Source:MakerDAO Whitepaper

3.4 Other Projects

In addition to Aave, Compound, and MakerDAO, there are also protocols such as Venus (a lending protocol on the BSC chain), JustLend (a lending protocol on the TRON chain), Cream, etc. Each project differs in collateral asset types, community governance, token economics, and other aspects.

4. Common Uses and Scenarios of Borrowing

4.1 Liquidity Mining

In many DeFi projects, users can use borrowed funds to participate in liquidity mining again, and obtain additional income. However, this also brings higher leverage risk. Once the collateral price falls or the yield decreases, it may lead to insufficient margin and be liquidated.

4.2 Deleveraging and Leveraging

• Deleveraging: If users hold a large amount of encrypted assets and are concerned about short-term market downturn, they can borrow stablecoins to hedge against price fluctuations.
• Leverage: Conversely, if a user is bullish on the appreciation potential of a certain encryption asset, they can also mortgage assets to borrow the same or other assets to amplify their capital position.

4.3 Capital Turnover and Arbitrage \

Some traders use ‘flash loans’ for cross-platform arbitrage. For example, borrowing assets from Aave, then immediately conducting low-buy-high-sell or spread arbitrage on another platform, and then repaying the borrowed funds in the same transaction.

4.4 Liquidity Management

Institutions or individuals may also use borrowing to manage liquidity. For example, if you have locked ETH but need stablecoin funds in the short term, you can collateralize ETH to obtain DAI or USDT to meet short-term funding needs without selling ETH.

5. Risk and Challenge

5.1 Smart Contract Risks

\
The core of blockchain lending platform is smart contract. If there are loopholes in the contract, it may lead to fund theft or systemic losses. Users must consider whether the platform contract has undergone sufficient security audit and public testing.

5.2 Market Volatility Risk

\
The volatility of cryptocurrency prices is generally higher than that of traditional assets. Although overcollateralization can reduce some default risks, in extreme market conditions, the value of collateral may also plummet, leading to automatic liquidation.

5.3 Liquidity Risk

\
Once a large number of users withdraw funds simultaneously or the market sentiment fluctuates sharply, there may be a situation where the funding pool becomes depleted or there is a strong demand for borrowing but no one is willing to lend, causing drastic fluctuations in the lending rates and affecting the stability of the platform.

5.4 Systemic Risk

\
Decentralized lending is often interconnected. If a protocol experiences a security incident or an economic collapse, it may have a cascading effect on other DeFi products that rely on that protocol, causing market panic and a massive exodus of funds.

6. Overview of Token Mechanism and Economic Model of Lending Platform

Lending platforms generally issue platform governance or utility tokens to incentivize user participation, governance voting, and profit distribution. The following table briefly compares the token mechanisms of several representative platforms:

From the table, it can be seen that the tokens of lending platforms usually have two core functions: governance rights and value capture.

1. Governance: Token holders can propose and vote on platform operations, risk control strategies, collateral types, and interest rate models.

2. Value capture: Some platforms will allocate the interest income or liquidation fees generated by the lending agreement to token holders in a certain proportion.

3. The Future Outlook of the Lending Sector

7.1 Compatible with more assets and cross-chain ecosystem

\\
As the interoperability of blockchain increases and Layer 2 networks mature further, lending platforms will be more easily connected to multiple public chains and more asset types, achieving cross-chain collateral and cross-chain lending, further improving liquidity.

7.2 Emerging Lending Models

• Unsecured or low-collateral lending: If a more comprehensive credit assessment system can be established on the blockchain (such as on-chain identity, credit scoring), it will give rise to unsecured or low-collateral lending protocols, bringing higher capital utilization for individuals and institutions.
• NFT Collateralized Lending: Some platforms have started to explore using NFTs as assessable collateral, providing lending services for high-value NFT assets through collaborations with professional appraisal agencies or oracles.

7.3 Compliance and Innovation Go Hand in Hand

\
In the future, DeFi lending platforms will probably need to balance regulatory requirements and the advantages of decentralization, combining on-chain and off-chain data to launch products that meet the compliance needs of regulatory authorities and financial institutions, further expanding the market scale.

8. Summary

Borrow/Lend is a core function that cannot be avoided in both blockchain and traditional finance. It plays an important role in decentralized finance (DeFi) and directly affects the overall ecological health and user participation in the industry.

• From TradFi to blockchain finance: The lending platform has gone through a process from relying on centralized institution audits to relying on smart contracts and community governance, greatly improving efficiency and transparency. However, it still faces challenges in technical security and regulatory compliance.
• Mainstream projects and Token Economy: Projects such as Aave, Compound, MakerDAO, etc., provide a diverse range of lending options for the market, and also offer a paradigm of community governance and value capture in the token economy.
• Future Development: The lending sector will continue to evolve towards cross-chain and diversified collateral, and fully integrate with compliance and regulation, ultimately forming a more open and secure financial ecosystem.

If you want to further understand or experience encryption lending services, please feel free to browseGate.io Official WebsiteOr search and learn more about related projects on its platform, and be fully prepared for your investment and lending decisions.

Statement:

• Investment carries risks, and entering the market requires caution. This article does not serve as investment or financial advice provided by Gate.io or any other type of advice.