DeFi Lending & Borrowing
DeFi lending: Earn 3-8% on stablecoins (Aave $11.2B TVL) or borrow against ETH without selling. Liquidations happen below 1.0 health factor. Compare to Anchor's 19.5% before $40B Terra collapse May 2022.
How DeFi Lending Works
DeFi lending connects lenders and borrowers directly through smart contracts. No banks needed.
The Flow:
- Lenders deposit crypto into a lending pool
- They earn interest from borrowers
- Borrowers deposit collateral (more than they borrow)
- They pay interest to lenders
- Smart contracts enforce the rules automatically
Top Lending Protocols (January 2026):
| Protocol | TVL | USDC Supply APY | Networks | Launch Date |
|---|---|---|---|---|
| Aave | $11.2B | 3.8% | 7+ chains | January 2020 |
| MakerDAO | $8.4B | 5.0% (DSR) | Ethereum | December 2017 |
| Compound | $2.1B | 3.2% | Ethereum | May 2018 |
| JustLend (Tron) | $1.6B | 4.5% | Tron | August 2020 |
Before Terra's collapse (May 2022), Anchor offered 19.5% APY on UST deposits with $20B+ TVL. Seemed sustainable for months, then catastrophic failure wiped out $40B in 72 hours.
Current rates (3-8%) are sustainable because they're backed by real borrower demand, not unsustainable subsidies. Lower returns = safer protocol.
In DeFi, you must deposit MORE collateral than you borrow. This protects lenders if you can't repay. Typical ratio: 150% collateral for 100% loan.
Lending: Earn Interest
How to Lend on Aave:
- Go to app.aave.com
- Connect your wallet
- Choose asset to supply (ETH, USDC, etc.)
- Enter amount
- Approve and supply
- Start earning interest!
Real Lending APYs (January 2026):
| Asset | Aave APY | Compound APY | Risk Level |
|---|---|---|---|
| USDC | 3.8% | 3.2% | Low-Medium |
| USDT | 3.5% | N/A | Low-Medium |
| DAI | 4.1% | 3.4% | Low-Medium |
| ETH | 1.2% | 0.9% | Medium (volatility) |
| wBTC | 0.8% | 0.6% | Medium (volatility) |
Stablecoins earn more because:
1. Higher borrower demand for stables
2. People borrow stables to use long positions
3. Lower supply of stablecoin lenders
ETH/BTC earn less because:
1. Lower borrowing demand
2. More people holding = more supply
3. Volatility risk for borrowers
Most DeFi rates are variable - they change based on supply and demand. High demand to borrow = higher rates for lenders. Low demand = lower rates.
Lending Benefits:
- Passive income on idle crypto
- No lockup - withdraw anytime
- Higher rates than traditional savings
- Full control of your assets
Borrowing: Loans Without Selling
Why Borrow Instead of Sell?
- Keep exposure to your assets (if price goes up)
- Avoid taxable sale events
- Access liquidity without losing position
- Use (advanced, risky)
How to Borrow on Aave:
- First, supply collateral (ETH, BTC, etc.)
- Click "Borrow"
- Choose asset to borrow
- Check your "Health Factor"
- Enter amount (stay safe!)
- Confirm transaction
Health Factor shows how safe your position is:
- Above 1.5 = Relatively safe
- 1.0-1.5 = Getting risky
- Below 1.0 = LIQUIDATION
If collateral value drops too much, you get liquidated!
Common Use Cases:
- Borrow stablecoins against ETH to pay bills
- Take USD loan without selling BTC
- Use trading (advanced, high risk)
Risks to Understand
Liquidation Risk
If your collateral value drops, your position can be liquidated. You lose your collateral plus a penalty fee.
Smart Contract Risk
Bugs in code can lead to loss of funds. Use established, audited protocols.
Interest Rate Risk
Rates can spike during high demand. Your borrowing cost could increase suddenly.
How to Stay Safe:
- Keep Health Factor above 2.0 (conservative)
- Monitor your position regularly
- Have extra collateral ready to add
- Use stablecoins as collateral for lower risk
- Start small to learn
Starting position:
Collateral: 10 ETH at $4,000 = $40,000
Borrowed: $25,000 USDC (62.5% LTV)
Health factor: 1.32
ETH crashes 45% to $2,200:
Collateral value: $22,000
Debt: $25,150 (with interest)
Health factor: 0.85 ← LIQUIDATED
Liquidation penalty:
Liquidator repays $12,575 of debt
Receives 6.25 ETH ($13,750 value)
Liquidation bonus to liquidator: $1,175
Your final position:
3.75 ETH left ($8,250 value)
Still owe $12,575 debt
Net equity: -$4,325 (underwater!)
Started with $15k equity, ended with negative equity.
Total loss: $19,325
Liquidation Timeline: How Fast It Happens
| Time | Event | What Happens |
|---|---|---|
| T+0 | Market crash | ETH price drops sharply |
| T+1 min | Health factor < 1.0 | Position flagged for liquidation |
| T+2 min | Liquidation bots activate | Bots compete to liquidate you |
| T+3 min | Transaction confirmed | Your collateral is seized |
| T+4 min | Done | You've lost 5-10% + your position |
ETH dropped from $195 to $85 in hours
$9M+ in Aave liquidations
Gas fees spiked to 200+ gwei
Liquidation bots paid $500+ in gas per transaction
Many users couldn't add collateral fast enough
Some positions went into bad debt (protocol loss)
Lesson: Keep health factor above 2.0 minimum. During extreme volatility, even 1.5 isn't safe.