Lending Protocol

A lending protocol is a DeFi application that lets users lend crypto to earn interest and borrow crypto against collateral, with all terms enforced by smart contracts rather than a bank. Lenders deposit assets into shared pools; borrowers draw from those pools after locking up collateral worth more than their loan. Interest rates adjust algorithmically with supply and demand — heavy borrowing pushes rates up, attracting more deposits.

Aave and Compound are the classic examples. A user might deposit USDC into Aave and earn a floating interest rate paid by borrowers. Another user deposits ETH as collateral and borrows USDC against it — perhaps to spend without selling their ETH, or to open a leveraged position. If the ETH collateral falls too much in value, the protocol automatically liquidates part of it to repay the loan, protecting lenders.

A common misconception is that these are credit products like bank loans; they are not, because there is no credit check and no trust involved — every loan is overcollateralized, and solvency is enforced mechanically by liquidations. The main risks are smart contract bugs, oracle failures feeding bad prices into the system, and cascading liquidations during market crashes. Lenders should understand that their deposits are only as safe as the protocol's code and its liquidation machinery.