How to Build a DeFi Lending and Borrowing Platform?
With the quick advancement of blockchain solutions and their rapid entry to many traditional domains of human activity, the financial sector has also become affected. From numerous Neobank launches to the development of DeFi products, many new participants have entered the financial sector with more loyal, accessible, and flexible financial solutions for the population. Thus, DeFi, which is an acronym for decentralized finance first launched by Ethereum, promises many changes to global finance, with the Total Value Locked (TVL) in DeFi development projects exceeding $20 billion in 2020.
With these figures in mind, one may see that the pace and scale of the financial sector’s transformation via blockchain is increasing, promising many more disruptive projects transforming the financial landscape and changing how people store, exchange, and borrow money.
One of such blockchain-powered innovations is the DeFi borrowing and lending platform – a type of blockchain resource giving access to finance to otherwise unbanked or underbanked populations. In this review, the 4IRE team explains what it is, how it works, and what risks and benefits of using a DeFi lending and borrowing website are.
What is DeFi Lending?
In classical finance, borrowing and lending work as follows: clients with funds give them to the lenders in exchange for a predetermined interest rate. In this way, people gain profit by letting others use their money. The process is supervised by a centralized financial institution, such as a bank or a specialized loan broker so that all parties comply with the terms.
DeFi, as its name suggests, is essentially a decentralized, trustless space in which peers can provide loans to other peers without third-party supervision. Parties’ compliance to the loan’s terms is guaranteed automatically with the help of smart contracts – self-executing and automated tools in which both sides’ obligations and conditions of contract execution are encoded.
Similar to conventional finance, DeFi also offers numerous avenues for lending and borrowing to their users. One party holding some crypto assets in coins or tokens as their investment and not needing them for regular use at present can lend those assets to another party at an interest rate specified in the smart contract. So, to date, DeFi system users can follow one of the possible paths to get a loan:
- Resort to some DeFi intermediary’s assistance (e.g., BlockFi or Celsius), which is an option for those requiring good liquidity and additional security guarantees;
- Engage in peer-to-peer lending without the involvement of third parties.
Let’s consider all mechanisms involved in the process of lending and borrowing funds via a DeFi system.
How Does DeFi lending Work?
Though the name “DeFi” suggests an entirely decentralized nature of financial operations, experts still caution against associating all blockchain-based financial products with DeFi. Here, one should note the difference between CeFi and DeFi in the classical sense of this term:
CeFi is a blockchain-based financial platform providing lending and borrowing services to users, with the platform’s owner assuming custody of the operations and asset security. CeFi platforms typically require KYC forms from users to enhance the user fund protection and minimize risks.
DeFi is also based on blockchain technology, but it resorts to a completely decentralized model of lending and borrowing, which is peer-to-peer transactions. In this model, users are always in full control of their funds and hold their crypto assets in their wallets. DeFi resources give more privacy and confidentiality to users without requiring KYC compliance and ensure that users fulfill their obligations via smart contracts alone.
How Does DeFi Lending Differ from Traditional Finance? DeFi Loans Explained
In traditional terms, borrowing and lending occur via fractional banking, meaning that people with excess money give their funds to banks in the form of deposits, while people lacking money for some goals borrow that money for a specific interest rate. Thus, the bank serves as a guarantor that the lender will get their money plus a predetermined interest rate within the specified term, while borrowers will return the funds plus a certain percentage for the use of other people’s money.
The same takes place in the crypto world, with people having funds in their possession giving those resources to other people, with or without the assistance of a credible intermediary – a DeFi platform. Here’s how the lending process is organized:
- Those wishing to derive interest from their crypto possessions come to the platform of interest and deposit their tokens in the so-called “money market.”
- The deposit is organized with the help of a smart contract that stipulates the terms on which the lender provides their tokens into use – duration of that deposit, expected interest rate, etc.
Reasons for borrowing in crypto assets instead of fiat currency are different. Some traders need to cover unexpected expenditures that they incurred within the crypto platform, while others may simply not want to sell their assets, being afraid of their abrupt price increases in the future. Besides, token sales in many countries are subject to the capital gain taxation, paying which makes no sense if the investor soon plans to repurchase their assets again.
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DeFi Lending vs. Staking
Both staking and lending are based on the principle of giving one’s assets to the trading network in return for potential gains, or interest. Still, these two approaches to getting passive income from your crypto belongings have some distinctions.
Staking presupposes putting the network’s native assets into a network to ensure its liquidity and support its functioning. Thus, your investment is secured by the network’s flawless operation and can dwindle if the network experiences some problems.
Lending is much securer in terms of value assigned to your assets. You can provide various tokens for the borrowing and lending platform; those funds will be put into a liquidity pool, with the interest rate determined dynamically depending on the changes in demand for those tokens’ borrowing.
DeFi Lending and Borrowing Platforms and Financial Innovation
DeFi platforms have revolutionized the financial sector’s work principles, including how funds are lent and borrowed. For users, DeFi resources are a significant source of financial innovation and greater coverage of unbanked populations unable to access loans otherwise.
The indisputable benefits of DeFi lending and borrowing for users include:
- Speed and efficiency
Unlike traditional banking institutions, DeFi platforms enable the quick and timely provision of funds to borrowers. You don’t need to wait for days or weeks for the institution’s decision; everything takes place almost instantly.
- Different lending decision principles
The conventional balanced scorecard approach to decision-making in usual banks prevents many individuals from getting loans as they don’t have a credit history yet. In DeFi, everything is different, with more people able to access lending due to transparent and fair credit policies.
- Looser regulations
As a rule, lenders and borrowers need to comply with the KYC/AML regulations, so there is full transparency of the funds’ routes, and the asset owners can be confident in getting their money back.
- Transparency of operations
Due to the blockchain principles and characteristics, all operations connected with the asset ownership transfer are documented in the ledger. Thus, all participants know the status of their funds, track the transactions, and see which verified users access their assets.
- Flexibility of use
Using DeFi is extremely simple and hassle-free, with all users able to access their wallets and conduct transactions with crypto belongings from any place on the globe.
- Impressive cross-platform functionality
Most DeFi blockchain systems are interoperable, which means that users can access funds on one platform and use them for trading or exchanges on another platform. As a result of such interoperability, the DeFi universe transforms into a global interconnected network with smooth functioning and numerous user benefits.
- Self-executing nature of contracts
Another benefit distinguishing DeFi from traditional finance is the automated nature of operations encoded in the blockchain-powered smart contracts. As a result of using the smart contract technology, individuals can perform operations safely without involving third-party regulators.
Popular DeFi Lending Platforms
The top five DeFi lending platforms you can use today include:
- MakerDAO – the platform uses its native Maker currency supports the DAI stablecoin. Users of this resource can exchange ETH for DAI hassle-free, enjoying low price volatility.
- Aave – the network operates on Ethereum and offers peer-to-peer lending and borrowing to users based on the smart contract protocol.
- UniSwap – an Ethereum-based network operating since 2018 on the principles of a fully decentralized exchange (DEX).
- Harvest Finance – this DeFi aggregator is offering users a farming approach to their assets’ multiplication. It uses the FARM crypto coin as the platform’s native currency facilitating exchanges.
- Compound – this platform also allows users to lock their assets and tokenize them in the native coins, cTokens. Once the assets are locked, cTokens can be used for buying other assets and deriving the interest rate from the lent belongings. Users also derive profit from the token’s value increase.
Each of them has won a significant loyal audience due its large liquidity pools and extensive lending and borrowing features. Yet, dozens of other projects have been launched or are underway, suggesting that the future of DeFi is promising.
Essentials of Developing DeFi Lending Protocols
Given the popularity of DeFi platforms and the rise of borrowing and lending opportunities on them, you might consider launching your own project of this kind. Successful DeFi lending platform creation is impossible without the following elements:
- Research and project specification design
At this stage, you assign a research team to determine the current DeFi market landscape and formulate your upcoming project’s specifications. You should have a clear plan and vision of your DeFi platform, your target audience, the needs that your project will address, its core features, etc.
- Back-end development
Next comes the development of a DeFi protocol that will underlie your platform. You need to choose one of the popular blockchain solutions powering DeFi platforms and build your unique project based on its functionality.
- UX/UI design
Once the core back-end features are ready, it’s time to link the platform to its target users with an intuitive, user-friendly UI. Make your platform sleek and usable so that the users stick to it and choose it as their go-to DeFi provider.
- QA testing
Testing of the developed features is essential to ensure that your platform has no bugs or severe security vulnerabilities. A team of testers should try all functions in the demo mode; once all problems are corrected, you can proceed to the market launch.
Make sure to arrange a comprehensive advertising and marketing campaign so that as many users as possible learn about your project and join the platform. The market launch is a pivotal moment for your project, so you need to ensure that everything works flawlessly at this stage.
- Post-launch maintenance
Your work on the platform’s improvement doesn’t end after the launch; it’s vital to make critical updates and add new features so that users remain loyal to your resource. Regular support and maintenance also make a difference and form an essential element of good service’s functioning.
Here we’ve covered the most common questions that users have about DeFi lending and borrowing projects. You can find detailed answers to these inquiries below.
Is DeFi lending safe?
Yes, DeFi lending is safe as investors entrust their funds to the borrowers and predetermine all lending and borrowing terms in the smart contracts accompanying their operations. Thus, the process of lending and borrowing gets automated and fully secure.
What are the risks of DeFi lending?
First, the risk of smart contract tampering is always present, though it rarely happens for the investors to be concerned too much. The users borrowing money from DeFi platforms should possess at least a moderate level of technical knowledge and proficiency in the blockchain use. Each protocol and token have minor differences and peculiarities of use, such as supported wallets, fees, etc. Finally, the APY risks require constant monitoring as the interest rate on borrowed assets may change dynamically, with borrowers ultimately repaying too much for the loan to be reasonable.
What is the difference between lending and borrowing?
Here, everything is simple. Like traditional finance, lending is the act of giving money to other people in exchange for an interest rate. Thus, it’s a form of passive income for those who have some spare crypto assets and want to earn on them. Borrowing, in its turn, is the act of taking money from other people for temporary use in exchange for a predetermined fee (interest rate).