lending protocol

A DeFi lending protocol is a smart-contract money market where strangers can lend and borrow without ever meeting or trusting one another. Suppliers deposit assets into a shared pool and immediately earn interest; borrowers draw from the same pool but must first lock up collateral worth more than what they borrow. There is no loan officer, no credit score, and no fixed repayment date — everything is enforced by code and by economic incentives. Aave and Compound are the canonical examples; together with stablecoin vaults they form the backbone of on-chain credit.

Because borrowers are pseudonymous and cannot be chased in court, the loans are over-collateralized: to borrow 70 dollars of USDC you might need to post 100 dollars of ETH. Interest rates are not negotiated but set algorithmically by a utilization curve — as more of the pool is borrowed, rates rise to attract suppliers and discourage further borrowing, and they fall when the pool is mostly idle. When you supply, you typically receive a receipt token (Compound's cTokens or Aave's aTokens) that continuously accrues your share of the interest, so your claim grows just by holding it.

If a borrower's collateral falls in value until it no longer safely covers the debt, the protocol allows anyone to liquidate the position: a third party repays part of the debt and seizes collateral at a discount, keeping the pool solvent. This whole machine is composable — the receipt tokens can themselves be used as collateral elsewhere, deposits can be looped to lever up, and flash loans let anyone borrow uncollateralized within a single transaction. That composability is the source of DeFi's power and of its systemic, cascading risks.