DeFi lending and borrowing, explained

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Borrowing and borrowing in traditional as well as crypto finance involves the provision of an amount of money by one party – be it fiat or digital currencies – to another person in exchange for a steady stream of income.

The concept of “lending and borrowing” has been around for ages and is one of the core aspects of any financial system, especially the “fractional banking” structure that is prevalent worldwide today. The idea is extremely simple: that is, the lenders are making funds available to borrowers at a regular rate, and that’s literally it. Traditionally, such business is usually facilitated by a financial institution such as a bank or an independent company such as a peer-to-peer lender.

In the context of cryptocurrencies, borrowing and borrowing can be facilitated through two main avenues – through a central financial institution like BlockFi, Celsius, etc., or by using decentralized financial protocols like Aave, Maker, etc.

Although CeFi platforms are decentralized to a certain extent, they function almost exactly like most banks, with the custody of the assets in custody and ultimately lending them to third parties – such as market makers, hedge funds, or other user platforms – while the original depositor has one constant return achieved. And while this model looks and works pretty well on paper, it can be prone to a number of issues like theft, hacks, inside jobs, etc.

DeFi protocols, on the other hand, allow users to become fully decentralized lenders or borrowers so that a person has complete control over their funds at all times. This is made possible through the use of smart contracts based on open blockchain solutions like Ethereum. In contrast to CeFi, DeFi platforms can be used by anyone without having to pass on their personal data to a central authority.