A Simple Overview of DeFi Lending
As of now, the total value locked (TVL) in the DeFi lending sector is around $14.308 billion, which makes up about 18% of the entire DeFi ecosystem. This shows that lending is one of the fastest-growing areas within decentralized finance.
Most of this TVL is held by just three major lending platforms:
- Aave, which holds about 30%,
- JustLend, with 29%, and
- Compound, which holds 17%.
(You can read more about the current state of DeFi lending in a detailed article linked here.)
How Does DeFi Lending Work?
DeFi lending, or decentralized finance lending, is similar to traditional bank loans but happens through decentralized applications (DApps) instead of banks. Everything is done through blockchain-based smart contracts without the need for middlemen.
To borrow funds, a user must first deposit cryptocurrency as collateral into a lending platform. This is done via a smart contract, and the collateral amount must usually be higher than the loan requested.
If the value of the collateral drops too much, the system will automatically trigger a liquidation process to recover the funds.
One of the key features of DeFi is that anyone can become a lender. Users simply deposit their cryptocurrencies into liquidity pools offered by lending protocols, and in return, they earn interest for providing liquidity.
Borrowing Models in DeFi
1. Over-Collateralization
This is the standard borrowing method in DeFi. Borrowers must deposit more crypto than the value of the loan they wish to take.
This is necessary because cryptocurrency prices can fluctuate quickly, and over-collateralizing helps reduce the risk of defaults. The collateral is held securely in a smart contract until the loan is paid back.
2. Under-Collateralization
This model allows users to borrow with less collateral than the loan amount. However, this is still rare and hard to implement in DeFi, since there’s no credit scoring system like in traditional finance.
It’s challenging to lend to users with few assets, so many DeFi developers are now exploring credit scoring systems using blockchain and off-chain data to make lending more accessible.
3. Flash Loans
Flash loans are a special type of DeFi loan that doesn’t require collateral but must be repaid instantly—within the same blockchain transaction. These are mainly used by experienced users for purposes like arbitrage and quick trades.
If the loan is not repaid instantly, the transaction fails. Flash loans are a potential solution to under-collateralized lending, though they remain risky and complex.
Major Risks in DeFi Lending
Despite its growing popularity and innovation, DeFi lending comes with several significant risks. Below are four of the most common ones:
1. Liquidation Risk
Crypto prices can be extremely volatile. If the value of a borrower’s collateral drops too much, the smart contract will automatically sell the assets to cover the loan—this is called liquidation. In DeFi, there are no traditional intermediaries, so if a borrower defaults or gets liquidated, lenders may not recover their money.
2. Smart Contract Risk
Smart contracts are pieces of code that run on the blockchain. Once they are deployed, they can’t be changed. If a bug or vulnerability exists, hackers can exploit it to steal funds. Although most protocols get their smart contracts audited, audits alone can’t eliminate all risks.
3. Flash Loan Attacks
These attacks involve taking a flash loan and using it to manipulate the market or exploit loopholes in a protocol’s smart contract. The attacker earns a profit within a single transaction. If successful, this type of attack can cause massive losses for the platform and its users. A well-known example is the bZx flash loan exploit.
4. Impermanent Loss
This risk mainly affects liquidity providers (LPs). When the value of assets in a liquidity pool changes significantly, LPs may lose money compared to just holding the assets. This is called impermanent loss.
It’s more likely when token prices in the pool become unbalanced. Some platforms, like Uniswap, reduce this risk by paying LPs trading fees to offset potential losses.
How to Reduce Risk in DeFi Lending
For Individual Users:
- Keep an Eye on Investments: Always monitor your loan positions and the platform’s performance. If the collateral value drops or defaults increase, it may be time to act fast.
- Learn About Smart Contracts: Understand how the platform’s contracts work. If unsure, seek advice from someone who understands blockchain.
- Look for Insurance: Some DeFi platforms offer insurance against hacks and failures. Choosing these platforms can offer extra peace of mind.
For DeFi Protocol Developers:
- Perform Regular Security Audits: Hire third-party experts to audit smart contracts regularly to catch bugs before they’re exploited.
- Use Formal Verification: This process uses mathematical proofs to make sure the smart contracts will always behave correctly under any condition.
- Create Insurance Funds: Set up funds that can compensate users in the event of hacks or losses.
- Add Flash Loan Defenses: Prevent abuse by adding restrictions, like requiring loan repayment before other functions are triggered, or setting transaction limits.
How Centic Helps Minimize DeFi Risks
Centic is a powerful Web3 analytics platform that combines on-chain and off-chain data to improve safety in DeFi. It provides tools for both individual users and protocols to monitor assets, credit risk, and platform behavior.
Centic Portfolio
Centic’s user dashboard shows your current financial status, investment positions, and risk of liquidation, helping you act in time to avoid losses.
[Figure 2 – Dashboard showing user assets and lending positions]
You can also view real-time analytics of major DeFi platforms across multiple blockchains. This helps you stay informed and make smart, data-driven decisions.
[Figure 3 – Detailed view of Aave V3 performance on Centic]
Score Marketplace
FICO Crypto Credit Score
Centic has developed a credit scoring system that works similarly to traditional FICO scores. It ranges from 300 to 850, allowing both individuals and protocols to evaluate creditworthiness.
- For users: You can see your credit score and use it to develop safer trading strategies or qualify for under-collateralized loans.
- For protocols: The score helps identify high-risk borrowers and optimize lending strategies for capital efficiency.
[Figure 4 – FICO Crypto Score level chart]
Project Reputation Scores
This tool lets users rate and evaluate the trust level of Web3 projects—especially lending protocols. Soon, Centic will allow users to customize scoring models to better suit their individual needs.
Final Thoughts
DeFi lending continues to grow, but it faces serious risks such as liquidation, flash loan attacks, and vulnerable smart contracts. Managing these risks is crucial for both users and developers. Individuals should keep track of their investments and understand how the technology works.
At the same time, platforms must commit to strong security practices and proactive risk management.
Centic is building a reliable analytics ecosystem that rates the trustworthiness of Web3 entities. By providing accurate data and scoring systems, Centic empowers users to participate in DeFi more safely and confidently.
In short, Centic combines blockchain data and real-world information to create a safer DeFi environment, helping users make smarter, risk-aware decisions in both the digital and traditional financial worlds.
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