Lending and Borrowing

Crypto Lending

Crypto can be loaned or borrowed from many different places, some of which are centralised and some of which are decentralised.

How does it work on DeFi?

There are many DeFi protocols out there, including Aave, Compound, Maker, dydx etc. Let’s use Aave protocol as an example — how does lending work?

  1. You can get access to cash without selling your crypto, if you think the crypto will rise in value
  2. You can potentially avoid capital gains taxes (by not selling your crypto and taking out a loan)
  • Your collateral can be in one token and you can borrow a different token
  • You can find another way to make a good yield on the tokens you borrow

Is it Unlimited?

The amount you can borrow is not unlimited. When you click on a market you will see a few pieces of important information — Aave example given below:

  1. Available Liquidity — you can only borrow what is available in the pool
  2. Maximum LTV — Loan to Value ratio. For USDC the ratio is currently 82.5%, meaning if the user has deposited 1 ETH as collateral they can then borrow 0.825 ETH in USDC. If the debt in USDC becomes more than the LTV multiplied by the total collateral then a ‘margin call’ is made, where the protocol alerts you to give you time to add additional collateral to restore the LTV to below this maximum.
  3. Liquidation Threshold — when the debt is worth more than this value multiplied by the collateral value. To continue the example, when the debt in USDC becomes more than 0.85 ETH due to fluctuating ETH prices. At this point the collateral is used to pay off the debt, at least until the LTV is below the maximum value.

Optimisation

All of the protocols mentioned up to now are based on ERC-20 tokens, and what does that mean? GAS!

  1. Yield Optimisation — for example Yearn.finance, which has vaults of stablecoins that the smart contract automatically shifts around to different lending protocols depending on where the highest interest rates are.
  2. Flash Loans — by bundling several actions into a single Ethereum transaction you can borrow without collateral, use it to generate interest and repay the loan before the transaction is validated. If the loan is not repaid the transaction is cancelled as if nothing happened.

Concluding Remarks

Crypto lending can be a lower-risk approach to earn single-digit (sometimes double-digit) returns, predominantly on stablecoins — if you’re looking to diversify, this might be a method of passive income for you.

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