The mechanics of a cryptocurrency lend-lease platform.

If you've ever heard of Aave or Compound and wondered what these platforms do, this article explains it in simple terms.

What is it?

crypto lending and borrowing is a one-of-a-kind application in the world that allows users to deposit digital assets for interest, or loan assets using other cryptocurrencies as collateral.

Well-known examples are Aave and Compound, the forerunner of today's widely used money market model in DeFi .

Who pays interest to whom?

In a typical money market protocol, the depositor puts assets such as stablecoins or ETH into a common pool and receives tokens in exchange for their deposit along with accrued interest.

This is called over-collateralization, because the DeFi protocol doesn't have a way to verify the identity of the borrower or bring legal action like banks do.

What happens if the price of a security drops?

If the collateral value falls close to or below the amount of money borrowed in arrears, a smart contract will automatically liquidate some or all of it to pay off the loan, protecting depositors from losses.

And the interest rate is determined by an algorithm based on supply and demand for each asset in a pool, so if people want to borrow more of it, they're going to get higher rates.

What are the risks?

The point is that it's non-custodial and permissionless. Anyone can participate with a trusted wallet, no credit checks or documentation but three things:

• The perils of a genius contract. The code may have a loophole.
• The foreclosure sale was quick. A volatile market can destroy collateral in minutes.
• The rates change frequently. Well, based on market conditions it's not as stable as a bank deposit.

This article is for educational purposes only and does not recommend any lending platform.