The Basics
DeFi lending means lent and borrowed crypto on self-operating platforms. You put your coins into a pool to earn interest. Or you lock up some coins as a guarantee to use other coins.
The whole system runs without a middleman, so you deal directly with others on the blockchain. Smart contracts handle all the details, leaving loan rules run on their own. Lenders earn interest and borrowers get cash without having to sell their coins. Crypto prices tend to jump up and down fast, so this carries some risks.
Annual Percentage Yield (APY)
Annual percentage yield shows the yearly return on an investment, taking into account compound interest. In such P2P loans, it tells you how much interest you earn on assets you lend, or how much you have to pay when you borrow. Unlike banks, where charges stay the same for a set time, platforms often change APYs as users come and go.
Knowing APY helps you see possible gains or costs. A higher APY means better returns, so these types of loans are often seen as appealing when bank rates are low. These charges shift all the time because smart contracts adjust them to balance supply and demand. Some platforms calculate interest every few seconds on chains like Ethereum. You might even pick a “stable” APY on crowdlending sites such as 8lends, which stays the same for a while if you want predictability.
There is a trade-off. Higher APYs could yield higher rewards, but they also bring more risk. Smart contracts have weaknesses too. Markets may swing up and down. So it is wise to keep an eye on both the figures and the health of the platform you choose.
Here’s a quick example based on Compound Finance. If the cETH to ETH course grows by 0.0000000003 each block, and about five blocks happen every minute, your supply APY for a month will work out to roughly 2.005%.
On a 10 Ethereum deposit, that means about 0.2592 Ethereum in interest over thirty days. Frequent compounding like this might boost your earnings, but it also means you need to watch things closely.
Total Value Locked (TVL)
Total Value Locked shows how much money is sitting in a DeFi protocol at any moment. It is usually counted in US dollars or the protocol’s own crypto, like ETH for Ethereum projects. In lending pools, TVL means all the funds lenders have added to those pools.
TVL matters because it tells us how popular and liquid a protocol is. More TVL means more money is up for borrowing, so trades might happen more smoothly and the interest may stay steadier. It also shows that people trust the protocol and use it, making it easy to compare different projects. TVL tends to jump around with market ups and downs, and it only measures what is locked in, not the earnings generated from it.
Imagine someone puts $1,000 worth of Ethereum into a protocol. Another user then takes up $500, backed by that deposit. The TVL here becomes $1,500, counting both what is deposited and what is used. Investors watch this number closely, using it to decide if a protocol, like MakerDAO or Compound, looks ahead to a bright future. So TVL gives a clear snapshot of a project’s health and size at any time.
Collateral Ratio
This shows how much value you lock up compared with the loan you take out. In these loans, you usually need to lock up more value than you borrow. This extra cushion guards against sudden price swings. For instance, MakerDAO asks you to lock up $150 worth of Ethereum to use $100 in DAI. That works out to a 150% ratio.
If the value of your Ethereum falls below that level, your loan may be liquidated. Lenders stay safe this way. Each asset carries its own limit. Riskier tokens may only allow a 50% collateral factor. Stablecoins may go as high as 90%.
Let’s say you lock up $150 in Ethereum and take up $100 in DAI. If ETH’s price drops so that your security backing falls below $150, your position will face liquidation, and you’ll lose a bit extra as a penalty. This system protects lenders but could also cost borrowers. Keeping an eye on your collateral ratio is big.
Utilization Ratio
This measures how much of the total supply in a credit pool is actually borrowed. You find it by dividing the total borrowed by the total supplied. High-level utilization pushes interest rates up. Lower numbers result when there is more supply than demand. Most of these platforms adjust rates automatically based on that number.
Take a pool with $1,000 supplied and $800 borrowed. Its utilization ratio is 80%. With so much of the pool in use, rates rise to attract more suppliers and slow down utilization. Compound employs a simple formula: interest rate = 5% + 15% x the utilization ratio.
That means figures move from 5% at zero utilization up to 20% at full utilization. Other platforms like dYdX and DDEX apply steeper curves for faster rate changes. This ongoing innovation keeps DeFi credit both flexible and balanced.
Liquidation
Liquidation happens when a borrower’s collateral is sold to pay back their loan after its value drops too low. The protocol sets a safety score, often called a health factor, to make sure there is always enough of a guarantee. If the security backing falls below that score, it could be sold so that the loan stays covered. This keeps the system stable and the lenders protected.
DeFi has no credit checks or courts to step in. Instead, overcollateralization and liquidation handle the risk. When a position becomes undercollateralized, anyone could trigger a sale. They repay part of the loan and receive the collateral at a small discount. In some projects, if the health factor drops below 1, up to 50% of the debt can be paid off this way, and the liquidator earns a fee. This protects lenders but may be painful for borrowers.
Imagine you lock up 10 Ethereum worth $3,000 as collateral and use $2,000 DAI. Your liquidation limit is 80%. If Ethereum’s price falls and your guarantee dips below $2,500, your position could be liquidated. A liquidator steps in, pays part of your debt, and takes some of your Ethereum at a discount. You lose some collateral, but your remaining debt goes down.
Health Factor
The health factor shows how safe a loan is. It is calculated as: (the sum of each collateral’s value × its liquidation cutoff) ÷ total borrowed
All values are usually in Ethereum.
A health factor above 1 means your loan has enough backing. If it falls below 1, you don’t have enough security, and your position can be liquidated. This number gives you a simple signal so you can add more collateral or pay back some debt.
Stablecoins often maintain a high cutoff rate (around 80%), while riskier tokens sit closer to 65 %. That difference reflects how likely an asset is to swing in price. In busy markets, liquidators race to spot positions with low health factors and act fast when prices move.
For example, say you lock up $10,000 as a guarantee with an 80% cutoff and borrow $ 6,000. Your health factor is: (10,000 × 0.8) ÷ 6,000 = 1.33
That is above 1 and shows your position is safe. If the security value drops, pushing the health factor under 1, you face liquidation.
Conclusion
DeFi lending opens up new ways to lend and borrow crypto. Learning the terms helps you make smart choices and manage risks so that you feel more in control. Staying updated and using trusted platforms with smart contracts that have been checked is key to success. One of the highest-profile opportunities to make big profits with a low risk lately, by the way, is crowdlending. 8lends offers evenly spread-out risk among multiple projects backed by collateral for a 15% return rate.
