Traditional banking relies on intermediaries to facilitate loans and manage risk. Decentralized Finance (DeFi) replaces these institutions with self-executing code known as smart contracts. In a DeFi lending protocol, users can deposit cryptocurrency into a “liquidity pool” and earn interest, while others borrow from that pool by providing collateral.
The primary drivers of DeFi are:
- Accessibility: Anyone with an internet connection and a digital wallet can participate, bypassing traditional credit score requirements.
- Transparency: Every transaction and interest rate adjustment is recorded on a public blockchain, visible to all.
- Liquidation Risk: If the value of the borrower’s collateral drops below a certain threshold, the smart contract automatically sells it to protect the lenders, a process that happens in seconds without human intervention.