Lending & Borrowing (DeFi)

Beyond tokens and NFTs, some blockchain systems support financial applications that allow users to lend and borrow digital assets.

These systems are commonly referred to as decentralized finance, or DeFi.

What is decentralized finance (DeFi)?

Decentralized finance refers to financial applications built on blockchains that operate through smart contracts rather than centralized intermediaries.

These applications aim to provide services such as lending, borrowing, and asset exchange through code-based rules.

How lending works in DeFi

In DeFi lending systems, users can deposit assets into smart contracts that make them available for others to borrow.

Lenders may receive compensation based on predefined rules, while borrowers provide collateral according to system requirements.

How borrowing works in DeFi

Borrowers typically lock collateral into a smart contract in order to borrow other assets.

These systems use automated rules to manage risk, including requirements for collateral levels and liquidation conditions.

How DeFi differs from traditional lending

Traditional lending relies on centralized institutions to assess risk and enforce agreements.

DeFi systems rely on smart contracts and predefined rules, which removes intermediaries but places more responsibility on users.

Risks and limitations

DeFi systems come with risks that users should understand:

• Smart contract vulnerabilities
• Market volatility
• Liquidation risk
• Limited recourse in case of errors

Understanding these risks is important before interacting with DeFi platforms.

Common misunderstandings

A common misunderstanding is that DeFi eliminates risk or guarantees returns.

In reality, DeFi systems operate according to code and market conditions, which can change rapidly.

Key takeaway

Lending and borrowing in DeFi show how blockchain technology can be used for financial applications beyond simple transfers or ownership.

These systems offer new possibilities but require careful understanding, responsible use, and an awareness of their limitations.

Continuing your learning

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