How Crypto Lending Works and the Best Platforms to Use It

Loan is an integral part of the economy that has helped nations, businesses, and individuals rise for centuries if used properly. However, most people are familiar with credit in the form of centralized banks and mostly in the form of USD and other national currencies.

Loan is an integral part of the economy that has helped nations, businesses, and individuals rise for centuries if used properly. However, most people are familiar with credit in the form of centralized banks and mostly in the form of USD and other national currencies. But for DeFi to become a full-fledged economic framework, the emergence of credit mechanisms was inevitable — and by now, several functional implementations are in place.

But it works a bit differently than in TradiFi, and here we will go into more detail on how crypto lending works, the difference DeFi vs centralized crypto lending, and what secure crypto borrowing platforms there are today.

What Are the Advantages of Crypto Lending and Borrowing?

Some may ask why crypto loans are needed instead of the usual TradiFi loans from classic banks. There are several reasons for this.

* Institutional Bias

Banks are not always fair in deciding who to lend to or not. Of course, we are not talking about cases of outright unreliability, but on average, a bank may not give a loan to someone who could use it very well and return the loan on time and in full. DeFi mitigates this issue by removing human discretion and enabling access to credit based on objective, algorithmically enforced conditions.

* Banks Non-Transparency

Banks apply opaque decision-making criteria, often relying on proprietary risk models that are inaccessible to applicants. You don’t know until the end why the bank denied your loan and what exactly you need to do to fix it. DeFi protocols are fully transparent: Loans are issued according to publicly auditable smart contracts with predefined parameters.

* Banks Limitations

In the case of classic banks, you have very limited options. All of them have approximately the same conditions, and there is no fundamental difference in which bank to borrow from. You can only borrow from a small list of traditional currencies, which is also quite limited. Also, banks often share the same data about borrowers, and if you are denied by one bank for any reason, you most likely will be denied by the rest. DeFi provides a much larger selection of different platforms, mechanisms, and offers that can be much more convenient for a variety of user scenarios.

* It Is Impossible to Make a Profit From Loans

In TradFi, loan issuance is typically restricted to licensed financial institutions, and yield generation is not accessible directly to retail users. Sure, you can get interest from your deposit, but those are pretty limited options too and not the most direct ones. You don’t decide how the bank manages your money, who to lend to, and so on. DeFi allows you to lend on your own, choose transparent terms, and have a pretty wide range of choices in doing so.

How Crypto Lending Works?

So, the foundation of cryptocurrency lending is a model of overcollateralized loans, in which a user provides a digital asset as collateral and receives a loan in another cryptocurrency or stablecoin. Such an architecture is necessary due to the lack of creditworthiness assessment mechanisms in the blockchain environment: all loans are a priori considered unreliable if they are not secured by an asset whose value exceeds the loan amount.

However, there is a principle difference between DeFi vs centralized crypto lending, as these are two different architectural solutions that have different mechanisms for interacting with users and securing assets.

In decentralized protocols (DeFi) such as Aave, Compound, Morpho Blue, or FraxLend, the entire lending process is automated through smart contracts. This means that the user interacts directly with the protocol: deposits collateral, initiates a loan, receives tokens or stablecoins, and then repays the loan or replenishes collateral as needed. All actions are recorded on the blockchain, ensuring complete transparency.

Key parameters when lending with DeFi:

* The minimum overcollateralization ratio depends on the protocol and may vary from 110% to 150%. For example, to borrow 1 BTC, you may need to provide 1.2 BTC or 1.5 BTC in collateral, the same or another supported cryptocurrency.

* Interest rates are typically variable and adjust automatically based on market demand and the total amount of funds deposited in the protocol's liquidity pool.

* The lending process is executed immediately upon sufficient funds being deposited in the protocol and the user meeting the required conditions.

* Each action, such as depositing, borrowing, or modifying a loan, incurs a gas fee, which is paid in the native chain's cryptocurrency (e.g., ETH on Ethereum).

In centralized platforms (CeFi), the principles remain similar, but the management of the process is outsourced to a centralized organization.

Platforms like Nexo, Ledn, YouHodler, or Binance offer loans in fiat currency or crypto against digital assets. They manage risk through internal liquidation mechanisms and sometimes insurance funds. These services typically require KYC and offer fixed rates.