A Lending Protocol is a set of automated, transparent, and decentralized rules that allows users to lend and borrow cryptocurrency without a traditional bank or intermediary.

The DeFi Alternative to a Bank

A lending protocol is a core component of the DeFi ecosystem. Instead of a bank holding your money and lending it out to others, a lending protocol uses a liquidity-pool. Lenders add their assets to the pool and earn interest, which is paid by the borrowers. The interest rates are determined automatically by a smart-contract based on the supply and demand of the assets in the pool.

The lending process is also automated. A borrower simply provides cryptocurrency as collateral and is then able to borrow another asset from the pool. Because the system is overcollateralized, a borrower must deposit more assets than they are borrowing to ensure the loan is always secured. If the value of the collateral drops below a certain point, the smart-contract will automatically liquidate the collateral to pay back the loan, ensuring the lender's funds are safe.

Why It Matters

Lending protocols have democratized finance by allowing anyone with an internet connection to become a lender or a borrower, without the need for a credit check or a bank account. This has unlocked massive amounts of liquidity and allowed for a new era of financial innovation that is more transparent, efficient, and open to all.