Key Components of DeFi Lending and Borrowing Mechanism
There are various challenges and shortfalls of the current lending and borrowing system, such as restrictive funding criteria, geographical or legal restriction to access banks, high barriers to loan acceptance, and the exclusivity of only the wealthy to enjoy the benefits of low-risk high-returns lending.
In the DeFi landscape, such barriers do not exist as banks are no longer necessary. DeFi lending and borrowing protocols operate as a liquidity pool that is built on a blockchain network. Suppliers supply assets to the pool and earn interest, while borrowers take a loan from the pool and pay interest on their debt. This bridges the gaps between lenders who wish to accrue interest from idle funds and borrowers who wish to borrow funds for productive or investment use.
How much interest will you receive, or pay?
Interest rates are denoted in Annual Percentage Yield (APY) and differ between assets. The APY is algorithmically set based on the supply and demand of the asset. Essentially, the higher the borrowing demand, the higher the interest rate (APY) and vice versa. This lowers the friction between for lending/borrowing by allowing suppliers/borrowers to interact directly with the protocol for interest rates without needing to negotiate loan terms (eg. maturity, interest rate, counterparty, collaterals), thereby creating a more efficient money market.
What happens when the price of the collateral asset moves?
Before borrowing, you must supply assets into the system as collateral for your loan. Each asset has a different collateral factor. The more assets you supply, the greater is your borrowing power. Borrowed assets are sent directly to your wallet and from there, you can use them as you would any crypto asset.
If the value of the asset you used as collateral goes up, your collateral ratio also goes up, nothing will happen, and you can draw a bigger loan if you’d like to. If the collateral goes down such that your collateral ratio is now below the required collateral ratio, your collateral will be partially sold off along with a liquidation fee. The process of selling off your collateral so that you achieve the minimum collateral ratio is known as liquidation. This is to ensure that there is always excess liquidity for withdrawal and borrowing of funds.
About Vee Finance
Vee Finance is a DeFi lending platform committed to bridging the gap between traditional finance and DeFi, providing users with superior digital asset management services. Both new and advanced crypto users can take advantage of our highly intuitive platform to supply, borrow, trade and do much more with their crypto assets.
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