Definition of DeFi loans
DeFi protocols provide users with a platform to borrow and lend crypto assets. These platforms support P2P lending on the respective networks, removing the need for third parties and, more importantly, banks and other centralized lenders.
Crypto lenders can earn interest by depositing their cryptos on a DeFi platform and staking their cryptoassets.
Longer-term Crypto Hodlers can earn annual percentage yields (APYs) that dwarf those offered by more traditional financial products. While this gives lenders and borrowers access to income and liquidity, the APY movement dictates the rigidity of crypto deposits.
DeFi v Traditional finance explored
In traditional finance, fiat currency deposits have tended to be much stickier, i.e. deposited for the long term, allowing banks to entrust money to borrowers to offer net interest margins and bank profits.
In the DeFi world, crypto hodlers seek out the best APYs, which leads to sudden movements in the total value locked, depending on market conditions.
For hodlers looking for the best returns, this can be a time-consuming process. More importantly, it can also be difficult to carry out the necessary research to identify the most suitable DeFi platform.
Borrowers in the DeFi space face similar benefits and pitfalls. Crypto loans provide easy access to funds to meet unexpected expenses and provide additional liquidity. It is particularly beneficial during bearish crypto market trends, where borrowers prefer to hold rather than sell crypto at a loss to access liquidity.
However, unlike more traditional loans, the volatility associated with crypto means that borrowers should tread carefully. Collateral pledged should cover fluctuations in crypto prices. Borrowers should also understand DeFi liquidation procedures.
DeFi platforms set liquidation parameters to protect against under-collateralized loans and ultimately platform illiquidity. Essentially, liquidations are comparable to stop-loss mechanisms in a trading environment.
In cases where the collateral is within the range of the loan amount, DeFi platforms allow third-party network participants to repay outstanding debt at a discount in exchange for the pledged collateral.
For this very reason, it is essential that borrowers monitor and maintain the appropriate level of collateral to avoid forced liquidation and loss of pledged crypto assets.
While the DeFi space provides a way to enhance passive income and for borrowers to access liquidity, both must take into account the volatility of the crypto market and, for borrowers, borrowing APYs and the risk of losing pledged assets in a crypto market event.
Chasing the highest APYs in the DeFi space
To perform APY comparisons and track protocol changes, investors can access products that assimilate data from lenders, including TraderJoe, AAVE, Geist, Iron Bank, and Venus.