If you have been involved in the blockchain space over the last year, then you may have noticed a sudden shift in the way many people use their cryptocurrencies thanks to rapidly growing interest in decentralized lending.
Prior to the advent of blockchain technology, one of the simplest ways to earn money would be to deposit cash in a savings account. But this has recently proved to be an incredibly inefficient way to make use of capital — since banks often earn more than 10% APY on user deposits, while providing an incredibly low average yearly interest rate of 0.05% in the US and 0.19% in the UK.
For comparison, peer-to-peer blockchain-powered lending protocols like Aave currently offer up to 5% on some stablecoins, while some more innovative platforms can offer upwards of 20% at times. This is largely down to the increased efficiency that comes with leveraging blockchain and cryptocurrency technology to cut down intermediary costs and better match supply with demand.
How Does It Work?
In the last four years, in particular, the blockchain landscape has seen an explosion in the number and variety of platforms that allow users to extract a yield from their idle assets.
As a result, there are now somewhere in the order of hundreds of blockchain-powered platforms with yield generating qualities, leveraging a variety of techniques to help deliver a return to their users.
Some of these platforms leverage a process known as liquidity mining to reward users with a newly emitted token in return for locking up their liquidity provider (LP) tokens. Others allow users to simply stake their tokens to help support the protocol in one or more ways — such as bolstering its security, growth, or efficiency. These platforms generally reward these users with staking rewards in proportion to their stake.
But by far the most popular and successful yield-bearing platforms are blockchain-powered lending platforms, which include open lending protocols like Compound and Aave, as well as centralized crypto-native lending/borrowing platforms like Nexo and Celsius.
Image courtesy: CoinMarketCap Interest
These new blockchain-enabled lending platforms all generally have one thing in common, they allow users to securely deposit their funds, which are then loaned out to overcollateralized borrowers. The fees these borrowers pay is then split proportionally between all those that contributed their assets to the platform, minus a variable deduction the service charges as commission.
For the most part, these borrowers are “overcollateralized”. This means they must put down more than 100% of the amount they borrow (sometimes several fold more) to protect against volatility and ensure repayment. If they default on the loan, or their collateral falls below a specified maintenance margin (e.g. 110%), it will be liquidated to reimburse the lenders.
This system allows these platforms to offer users a far higher return than offered by many traditional banks — which typically provide depositors just a tiny fraction of what they earn for lending their funds out.
The Current State of Play
Right now, decentralized finance (DeFi) is a more than $100 billion industry that is dominated by peer-to-peer lending platforms.
On Ethereum alone, four of the top five DeFi protocols by total value locked (TVL) fall into the lending sector — largely due to the clear-cut benefits these platforms offer to both borrowers and lenders.
On one side, lenders are able to get a relatively safe, fair yield on their deposits, while borrowers are able to source liquidity from their current cryptocurrency holdings without being forced to exit their positions. As a result, these lending protocols are frequently used as a means to multiply exposure to the market, while paying less than most banks charge for a loan.
As it stands, the largest lending platforms (both centralized and decentralized) have a TVL in the billions of dollars range and manage loans for potentially hundreds of thousands of individual borrowers. As a result, platforms like Compound and Aave are now among the most popular platforms for cryptocurrency holders looking to generate a yield on their assets and are second to just centralized exchanges when ranked by TVL.
Image courtesy: DeFi Pulse
But it’s not just Ethereum-based platforms that have seen a dramatic boom in usage in recent months. Other smart contract-capable blockchains including Binance Smart Chain (BSC), Terra, and Avalanche are beginning to see a similar uptrend in the popularity of decentralized lending platforms — with borrowers able to earn upwards of 20% APY through platforms like Anchor Protocol (and now Orion Money on BSC).
However, this has also led to a problem of choice overload among cryptocurrency holders, who are now inundated with options — many of which have overlapping features but can differ considerably in the returns they offer to users. Platforms like Relite have emerged to help tackle this challenge, by allowing users to easily stake a wide range of assets all in one place (regardless of which blockchain they are held on).
Likewise, yield aggregators like Yearn Finance and Harvest Finance have gained popularity recently among users looking to maximize their yield — since these platforms will automatically move funds between different protocols based on the expected yield. But as of yet, these platforms lack the ability to accomplish this across multiple blockchains, limiting their use among those with a more diverse cryptocurrency portfolio.
Nonetheless, the trend is clear. Decentralized lending platforms are increasingly demonstrating that blockchain technology can do a better job on what was historically one of the biggest functions of traditional banks. Future developments will likely continue to demonstrate this — potentially through the addition of decentralized fiat support, interoperability protocols, and increasingly novel yield generation and security mechanisms.
About Master Ventures
Master Ventures is a blockchain-focused venture studio helping to build the next generation of blockchain-based Web 3.0 system innovations within the crypto industry. Launched in 2018 by Founder and CEO Kyle Chassé, the company’s ethos can best be summarized in the acronym #BeBOLD: Benevolent, Open, Love, Decentralized.
Master Ventures co-creates with entrepreneurs and businesses worldwide to turn the best ideas into innovative and disruptive products. They do this by investing as strategic partners through offering advisory services to the projects they believe in. To date, Master Ventures has invested in over 40 crypto projects, including the likes of Kraken, Coinbase, Bitfinex, Reef, DAO Maker, Mantra DAO, Thorchain, and Elrond.
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