How DeFi Crypto Lending Works: Collateral, Interest, and Liquidation
Summary
The document explains the basic structure of decentralized crypto lending. Lenders deposit assets into liquidity pools and may earn interest; borrowers lock crypto as collateral to access other tokens or stablecoins. Smart contracts automate loan disbursement, interest accrual, and repayment, while insufficient collateral can trigger liquidation. Borrowing against an asset can provide liquidity without selling it, though it exposes the borrower to collateral price declines and debt value changes.
Using Aave as its main example, the article describes pooled liquidity, variable rates that respond to supply and demand, aTokens that represent deposited positions, and overcollateralized borrowing. It introduces loan-to-value ratios and Aave’s health factor as ways to understand borrowing capacity and liquidation risk. The explanation is conceptual and includes some protocol-specific details, but it does not compare protocols or quantify returns, fees, smart contract risk, or changing market conditions. Yield and access to liquidity are not guaranteed, and automation does not remove the possibility of loss.
Key ideas
- DeFi lending pools connect asset suppliers with borrowers through smart contracts.
- Borrowers generally lock collateral whose value determines their borrowing capacity.
- Interest rates can change with pool utilization and supply-demand conditions.
- Aave’s health factor indicates liquidation safety; falling collateral value can lower it.
- Borrowing against crypto preserves exposure but creates liquidation and protocol risks.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.