DeFi Lending Protocols — A Primer

A brief overview of major DeFi lending protocols

As a DeFi ecosystem and protocol, FinNexus aims to incorporate a number of different financial products including lending. This article grew out of our research into the current state of DeFi lending products. The ecosystem of DeFi lending protocols and applications has seen significant growth over the last year. It can be hard to keep track of all the different protocols and all their various similarities and distinctions. The following is a brief overview of several of the most prominent lending protocols and applications. This article covers the following protocols:

• MakerDAO
• Compound
• Dharma (Interface, not protocol)
• dYdX
• Nuo
• bZx (Fulcrum, Torque)

Thanks to https://loanscan.io, https://defiprime.com, and https://defipulse.com for providing such great info about the current DeFi ecosystem.

Why do people use DeFi lending protocols?

There are several primary reasons for using DeFi lending protocols.

1. In order to unlock the value of HODLed crypto without selling it

A long term crypto hodler who doesn’t want to sell their crypto investment but still needs to pay for their bills and food may take out a loan on their crypto so they can pay for their daily needs. BTC mining farm operators may want to take out loans to buy new equipment instead of selling their BTC when the price is low.

2. For margin / leveraged trading

A leveraged trade is a trade made with borrowed money. Margin refers to the collateral used to make the leveraged trade. Margin trading amplifies the investor’s loss or gain made on a trade.

3. To earn interest (as a lender)

Lending protocols serve as a way for holders of traditional crypto to earn a small amount of interest, or for holders of stable tokens to earn interest at rates often higher than through traditional savings accounts / bonds.

MakerDAO — 「The original borrowing protocol」

Borrowing: Yes
Lending: No
Interest rates: Set by a vote through the DAO
Minimum collateral: 150%
Margin trading: Manually outside the protocol
Liquidation penalty: 13%
Assets: DAI (borrow only), ETH (collateral only), MKR (for governance)

Borrower’s perspective:

MakerDAO is a two token system built on Ethereum using MKR tokens for governance, and the ERC20 USD targeted stable coin DAI for issuing loans. It allows borrowers to create a CDP (collateralized debt position) by locking ETH in a smart contract with a value higher than the amount of the DAI the borrower would like to generate. The user can then receive an amount of DAI less than the value of the ETH locked in the CDP. The ETH is now locked, and the user takes on debt equal to the amount of DAI they received. If the value of the ETH falls below safe levels, then the loan will be liquidated and the borrower will lose a portion of their collateral. Borrowers are therefore incentivized to over-collateralize their loans so as to avoid liquidations. The ETH will only be unlocked once the user pays back an amount of DAI equal to their debt plus a variable ‘stability fee’. The stability fee is essentially equivalent to the ‘interest’ paid on the ‘loan’ of the DAI. The stability fee is paid in the MKR token, and the tokens paid as fees will be burned. A ‘DAI savings rate’ is planned for the future to allow holders of DAI to earn interest, but it is not currently implemented.

Lender’s perspective:

There are no lenders in the traditional sense on MakerDAO. The cryptocurrency to be borrowed (DAI) is generated through the CDPs, rather than being drawn through a lending pool as in other protocols. In other protocols, individual lenders provide liquidity to the pool in exchange for an interest rate. In MakerDAO, liquidity is provided by DAI buyers (currently without earning interest — this will change with the release of the DAI Savings Rate/DSR ). In this way, DAI buyers can be considered to be taking the role of lender.

Margin trading process:

1. Generate DAI through MakerDAO borrowing process
2. Send DAI to an exchange
3. Make your trade
4. Close CDP on MakerDAO to complete

Notes:

• The entire MakerDAO system is quite complex, and the above description is only a very general outline of it. There are a number of different actors and systems on and off chain which must function properly for the entire MakerDAO system to work properly. Read more at MakerDAO’s website.
• The upcoming release of multi-collateral DAI and the DAI savings rate (DSR) will mark major changes to the protocol.

Compound — 「Lending & borrowing」

Borrowing: Yes
Lending: Yes
Interest rates: Currently set centrally using an algorithm which dynamically adjusts rates according to supply and demand
Minimum collateral: 133%
Margin trading: Manually outside the protocol
Liquidation penalty: 5%
Assets: ETH, DAI, USDC, REP, ZRX, WBTC, BAT

At its core, a Compound money market is a ledger that allows Ethereum accounts to supply or borrow assets, while computing interest, a function of time. The protocol’s smart contracts will be publicly accessible and completely free to use for machines, dApps and humans. — Compound Whitepaper

Borrower’s perspective:

From the borrower’s point of view, borrowing on Compound is similar to borrowing from MakerDAO. While there is no CDP mechanism, it is similar in that the borrower must first supply the protocol with cryptocurrency as collateral, which is then locked within the system. Based on the collateral provided, the borrower may then take out a loan, and the borrower must pay interest on the loan back into the system. Also as with MakerDAO, if the value of collateral falls below a certain point, the borrower is at risk of being liquidated.

Lender’s perspective:

Lenders in Compound choose which asset they would like to lend, and then supply that asset to a shared liquidity pool within the Compound protocol. Lenders can then earn interest on the assets which they have provided to the protocol. Note that this is not a P2P lending protocol — one individual lender never directly provides a loan to another individual, rather they are providing their assets to a joint liquidity pool.

Margin trading process:

1. Take out a loan on Compound for desired cryptocurrency through Compound’s own interface or one of several other interfaces built on top of the Compound protocol
2. Send crypto to an exchange
3. Make your trade
4. Close loan on Compound to complete

Notes:

• All markets in Compound use cTokens, which are ERC20 token receipts for the underlying tokens being used in the Compound protocol. The cToken exchange rate with the crypto it corresponds to is constantly increasing, which forms the basic mechanism for the interest rate. In practice, users do not need to worry about the technical details of cTokens — they simply supply their crypto to the protocol, and get the specified interest rate.
• Compound interest rates are determined by a dynamic formula which adjusts the rates according to the supply and demand of an asset.
• See Compound whitepaper or documentation for more details.

Dharma (Interface for Compound) — 「Lending & borrowing」

Dharma’s most standout feature is that it is the most simple and user friendly way to save and earn interest on crypto. It is essentially an alternative way to access lending on Compound products using a simplified and streamlined front end. While it began as its own protocol, the team later decided to build on top of Compound so that they could offer the most convenient and user friendly way possible to access decentralized lending. The platform relies on standard email based accounts instead of Metamask, so users do not need to manage private keys as they do with Compound. Users simply make an account with Dharma and deposit their DAI or USDC to the account supplied by Dharma to begin earning interest. Dharma is currently in beta and limited to USDC and DAI, it also currently supports lending only, and not borrowing.

dYdX「Lending & borrowing + margin trading」

Borrowing: Yes
Lending: Yes
Interest rates: Currently set centrally using an algorithm which dynamically adjusts rates according to supply and demand
Minimum collateral: 115%
Margin trading: Yes, up to 4x leverage
Liquidation penalty: 5%
Assets: ETH, DAI, USDC

Borrower’s perspective:

dYdX uses essentially the same approach as Compound — collateralized loans with algorithmically set interest rates which take advantage of a shared liquidity pool. One of the main differences is that they have a lower minimum collateral. The other major difference is that borrowers may margin trade directly through dYdX — they do not need to leave the protocol.

Lender’s perspective:

From the lender’s perspective the process is again quite similar to Compound. Tokens are deposited into the dYdX account and immediately begin earning interest.

Margin trading process:

1. Deposit crypto into your dYdX account
2. Borrow crypto through dYdX’s lending interface / OR deposit crypto into your wallet
3. Place a margin trade on dYdX’s integrated DEX

Notes:

• dYdX previously offered tokenized leveraged assets, such as sETH, but those have since been discontinued

Nuo「Lending & borrowing + margin trading」

Borrowing: Yes
Lending: Yes
Interest rates: Currently set centrally using an algorithm which dynamically adjusts rates according to supply and demand
Minimum collateral: 150%
Margin trading: Yes, up to 3x leverage
Liquidation penalty: 2%
Assets: ETH, DAI, KNC, ZRX, MKR, REP, BAT, WBTC, USDC, LINK, TUSD

Borrower’s Perspective:

The experience of borrowing on Nuo is very similar to Compound and dYdX. As with the other protocols, it allows for users to supply an excess of collateral which they can then take out loans on.

Lender’s Perspective

The lending user experience in Nuo is similar to the above protocols.

Margin trading process:

1. Signup and create Nuo smart contract
2. Deposit ETH or ERC20 tokens
3. Make trade

Notes:

• When compared to other protocols in this article, Nuo stands out for its user friendliness. In addition to MetaMask access, Nuo also offers traditional email / password based accounts which may be easier for some users. Nuo also has lower liquidation fees (200% of the liquidation transaction fees), than other protocols. Nuo also stands out for having the largest variety of assets available, and for having the highest interest rates.

bZx — Fulcrum / Torque — 「Lending & borrowing + margin trading」

(Note: bZx is a base level protocol, Fulcrum and Torque are two products built on top of bZx.)
Borrowing: Yes — through Torque (currently in beta)
Lending: Yes — through Fulcrum
Interest rates: Driven by market forces (on the base protocol, bZx) | Currently set centrally using an algorithm which dynamically adjusts rates according to supply and demand (on Fulcrum / Torque)
Minimum collateral: 150% initial, 115% minimum before liquidation
Margin trading: Yes — through Fulcrum, up to 4x leverage
Liquidation penalty: 200% of the gas paid for the liquidation transaction
Assets: ETH, DAI, USDC, WBTC, LINK, ZRX, REP, KNC

Borrower’s perspective:

The bZx protocol allows for lending, borrowing, and margin products to be built on top of it. The bZx team offers a borrowing product through the Torque project. Borrowing on Torque (currently in beta) is similar to borrowing on Compound or dYdX — an over-collateralized loan which gets liquidated when the collateral level falls below a certain percentage of the value of the borrowed funds.

Lender’s perspective:

Lending with bZx is done through the Fulcrum platform. While the technical implementation is somewhat different, the experience is similar to lending with Compound or dYdX. As in the two aforementioned protocols, users supply their tokens to a shared liquidity pool in order to earn interest on those tokens.

Margin trading process:

Margin trading is done through bZx’s Fulcrum platform, and the user experience is similar to others on this list such as dYdX or Nuo.

1. Connect to Fulcrum using MetaMask or other browser wallet
2. Select trade details and submit
3. Sign trade with MetaMask to execute trade through Fulcrum

Notes:

• bZx has several unique features which makes it stand out from other protocols. One very interesting feature is that in addition to variable rate loans it offers loans with fixed interest rates. The interest rates on all of the other mentioned protocols in this article are variable, meaning it is harder for a borrower to calculate what they will actually pay in interest over time. Another great feature is the use of ENS (Ethereum Name Service) human readable addresses, which makes interacting with the protocol much more user friendly. For example you could borrow DAI by simply sending your ETH to dai.tokenloan.eth.
• In addition to the base level protocol, bZx also offers what they term iTokens and pTokens, which are tokenized versions of a loan pool and position tokens respectively.

“These tokens allow for complex use cases not possible with the base protocol, allowing a high level of composability. iTokens can be packaged into novel products like gdai.io, a DAI that earns interest and uses that interest to pay for its own gas costs using GSN. Meanwhile, pTokens can be used as collateral for loans or packaged into more complex financial instruments such as ETFs or Structured Products using Melon or Set. Tokenization allows developers to easily build on top and create novel products in concert with other protocols.” — Kyle Kirstner, bZx co-founder

Sources:

1. https://hackernoon.com/how-decentralized-is-defi-a-framework-for-classifying-lending-protocols-90981f2c007f
2. https://loanscan.io
3. https://defiprime.com
4. https://defipulse.com
5. https://medium.com/dydxderivatives/decentralized-lending-an-overview-1e00fdc2d3ee

About FinNexus

FinNexus is the open finance protocol built on the Wanchain blockchain. It is a hub for connecting different decentralized ledgers to each others and users, and also for connecting with traditional finance applications. The first iteration of FinNexus will be a marketplace for hybrid decentralized/traditional financial products.

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