Lending and Borrowing

Module 3 of DeFi

How DeFi Lending Works

The Basics

1. Suppliers deposit assets → earn interest
2. Borrowers post collateral → borrow assets → pay interest
3. Smart contracts manage everything automatically

No credit checks. No KYC. Just collateral.

Over-Collateralization

Unlike traditional loans, DeFi requires more collateral than you borrow:

Traditional: Borrow $100,000 with income proof
DeFi: Deposit $150,000 ETH → Borrow $100,000 USDC

Collateral Factor: 66% (100k/150k)

Why Over-Collateralized?

• No identity verification
• No legal recourse
• Volatile collateral
• Trustless liquidation

Interest Rates

Rates adjust automatically based on utilization:

Utilization = Borrowed / Supplied

Low utilization (20%): 2% APR
Medium (50%): 5% APR
High (80%): 15% APR
Very high (95%): 50%+ APR

This incentivizes balance:

• High rates attract suppliers
• High rates discourage borrowing

Liquidations

When collateral ratio falls below threshold:

Deposit: 10 ETH at $2,000 = $20,000
Borrow: $15,000 USDC (75% LTV)
Liquidation threshold: 80%

ETH drops to $1,875:
  Collateral: $18,750
  LTV: 15,000 / 18,750 = 80%
  → LIQUIDATION

Liquidator:
  - Repays part of debt
  - Receives collateral + bonus (5-15%)

Liquidation Cascades

In crashes, liquidations cause more selling → more liquidations.

Flash Loans

Borrow millions with zero collateral — if repaid in same transaction.

Single transaction:
1. Borrow 1M USDC (no collateral!)
2. Arbitrage, liquidate, or refinance
3. Repay 1M + fee
4. If not repaid → entire tx reverts

Use cases:

• Arbitrage
• Collateral swaps
• Self-liquidation
• One-click leverage

Key Protocols

Key Takeaways

1. Over-collateralization replaces credit checks
2. Interest rates are algorithmic
3. Liquidations keep the system solvent
4. Flash loans enable complex atomic operations