Lending in Decentralized Finance: What to Know
Lending is a common strategy in decentralized finance. It is permissionless and does not exclude anybody from borrowing based on anything except their ability to provide collateral. For those that provide liquidity, it is also an interesting strategy to employ to compound the gains made in other DeFi strategies. There is value in this strategy because it allows the DeFi investor to earn gains without being exposed to the impermanent loss that comes with investing in liquidity pools. Lending assets usually returns a modest interest rate but acts as a useful strategy in a diverse portfolio.
The approach is quite straight forward on most protocols. As a case in point, I will focus on Liqwid Finance, a protocol on the Cardano blockchain. Below, you can see the assets that can be supplied and lent and the varying rate of interest that can be collected in the form of interest and platform rewards respectively.
You’ll notice in the image below that the borrow APR is a higher percentage number than the supply APY. This is something to be aware of when calculating expected returns or the rate of incurring debt over time. Another thing to be aware of is the status of the asset that is available to be lent. For example, in the image above, you can see that the two most common stable coins in decentralized finance are available to supply and borrow. Unfortunately, what is not disclosed is that these are currently supplied via WanChain Bridge from the Tron blockchain. This may also be the case for the decentralized stable coin DAI as well. It is good to stay on top of the news because recently Coin Desk announced that Circle are looking to pull approximately $300 million USD in value from that chain. If the USDC here is indeed underpinned by those assets on the Tron blockchain, then any USDC on Liqwid may become illiquid in the near future. This is why it is essential to follow the protocol via at least one of the social media channels to keep on top of the status of your deposited assets. If I were investing here, I would only be lending assets that are native to the Cardano blockchain (e.g. ADA, iUSD or DJED) to mitigate this risk.
Returns on different assets here can be higher than staking Cardano’s native asset ADA for example and this can be a quick way to increase earnings that can later be re-staked to earn a slightly lower rate of interest in a more secure manner. The relative simplicity of these protocols and the peer-to-peer lending principle makes this process ethically viable without the guardrails of traditional finance. DeFi platforms award liquidity providers a much higher share of the profits from loans than centralized banks do. Nobody needs permission to borrow money from this protocol or others like it such as Burrow or AAVE. This is good news for anyone that is frustrated with the inaccessibility of centralized financial markets.
Overall, lending still contains some economic risk. You need to trust the platform that you are investing in and accept smart contract and hacking risks. That said, lending here is a less risky strategy than providing to liquidity pools and slightly more risky than staking in a stakepool right within your wallet. It is essential to strategize in the market and determine your risk tolerance before making any investments.
Disclaimer: this is NOT financial advice. I’m a cow and I like to eat cereal. Any knowledge gained from this post is merely incidental and you are responsible for your own financial decisions. Make investments wisely and make sure to do your own research.
See my previous article on Liquidity Pools.
