The promise of Decentralized Finance (DeFi) is to transform financial services by providing transparency, security, and community governance by leveraging blockchain infrastructures.
Lending platforms have dominated the DeFi space, as they simulate traditional borrowing and lending services while relying on decentralized networks. As of June 2021, over $26 billion is locked in DeFi lending protocols, nearly half of the total TVL figure of all DeFi projects at more than $50 billion.
What Is DeFi Lending?
Conceptually, there is no major difference between DeFi lending and traditional lending. In a nutshell, lenders provide funds to borrowers in exchange for an interest rate.
However, the major differences manifest in the way these processes work. In traditional finance, loans are facilitated by banks and other financial institutions. In DeFi, all activity routes through decentralized protocols and there are no intermediaries involved.
Unlike traditional banking, DeFi platforms are borderless and can be used by anyone.
With DeFi lending, borrowers and lenders have total control over their funds as all processes are conducted by smart contracts, which are self-executing programs running on blockchain networks.
Lenders looking to benefit from interest rates on DeFi protocols have to deposit their digital currency, such as USDC, into autonomous lending pools. They do this by sending their tokens to a smart contract, making them available to other users for borrowing. In return, the smart contract issues interest tokens that are distributed automatically to the user and can be redeemed at a later date to access the deposited assets.
One distinct aspect of DeFi lending is that the majority of loans are overcollateralized, i.e., borrowers have to provide a guarantee that is greater than the loan value. This happens because most cryptocurrencies used as collateral are volatile, while there is no credit score or identity verification. Despite this, easy access to funds is an obvious advantage that attracts many users.
All in all, DeFi lending benefits both lenders and borrowers. The latter can secure loans conveniently, while the former can earn interest rates that are often higher than traditional rates offering a potential source of passive income.
Role of Stablecoins in DeFi Lending
Stablecoins play an essential role in DeFi lending protocols because they mitigate volatility risks and make it more convenient for both lenders and borrowers to better manage their financial operations on DeFi protocols.
USDC has been the fastest-growing dollar stablecoin, becoming the eighth largest cryptocurrency as of July 15, 2021, with a market cap figure of over $25 billion.
USDC dominates the DeFi space because it has a stable peg to the US dollar, is backed by regulated institutions – Circle and Coinbase – and is chain agnostic (available across multiple different blockchains and not connected to any particular DeFi protocol).
Data from FlipsideCrypto showed that USDC was the fastest-growing and most popular stablecoin across DeFi applications in the first quarter of 2021. For instance, the Total Value Locked (TVL) of USDC in DeFi protocols has increased from less than $50 million to over $1.5 billion as of July 15, 2021.
Even though USDC is a multi-chain token, the greatest share of its circulating supply is based on Ethereum, which makes it a convenient choice for most DeFi lending protocols, as they also rely on Ethereum smart contracts.
USDC has managed to remain at the top of the DeFi space thanks to its near-instant settlement speed, a high degree of security, and a major focus on transparency and regulatory compliance.
Circle’s stablecoin shows the smallest deviations from the $1 price target among the largest stablecoins according to data from Flipside Crypto, which makes it the best option for lenders looking for stability.
Lenders can deposit USDC to earn interest on their capital. USDC holders can lend their tokens on DeFi lending protocols, such as Aave and Compound. On Compound, USDC is the most deposited token, accounting for more than 25% of the total value locked in the protocol.