Over the past few years, decentralized finance (DeFi) has opened up innovative financial opportunities across the globe. Through DeFi, crypto holders can borrow funds or earn passive income by lending their crypto without a traditional centralized party involved.
However, this exciting new frontier comes with its own set of terminology. And for those venturing into this new world of open finance, these terminologies and concepts can be complex compared to traditional banking.
To help you understand these terms, we’ll discuss the meaning and significance of key terms you’ll encounter on your DeFi journey. We’ll also introduce Rocko, a user-friendly platform designed to streamline your DeFi borrowing experience. Continue reading to know more!
How Does DeFi Lending Work
DeFi lending protocols operate on decentralized networks, allowing individuals to lend and borrow cryptocurrencies in a trustless and permissionless manner. At its core, DeFi lending involves three primary stakeholders: lenders, borrowers, and the protocol itself. Here’s a step-by-step overview of how DeFi lending works:
- Lenders: Individuals or institutions deposit their cryptocurrencies, such as Ethereum (ETH), Wrapped Bitcoin (wBTC), US Dollar Coin (USDC), or other supported assets, into a DeFi lending protocol. This deposited amount is typically referred to as the “supply” or “liquidity”.
- Borrowers: Users can then borrow cryptocurrencies from the protocol by pledging collateral, usually in the form of another cryptocurrency. The borrower must meet the protocol’s requirements, such as providing sufficient collateral and agreeing to the loan terms.
- Protocol: The DeFi lending protocol acts as a decentralized intermediary, facilitating the lending and borrowing process through automated code. It ensures that the lender’s collateral is safely stored and that the borrower’s loan is disbursed accordingly. The protocol also sets the rules for loan terms, interest rates, and collateral requirements.
Once a borrower meets the protocol’s requirements, the loan is disbursed in the desired cryptocurrency. The borrower can then use the borrowed funds for various purposes, such as trading, yield farming, or other DeFi activities.
Throughout the loan period, the loan will accrue interest that is generally due upon full repayment. This interest is typically calculated based on the loan amount, interest rate, and loan duration. The borrower repays the loan, along with the accrued interest, using the same cryptocurrency borrowed. The protocol then returns the collateral to the lender minus any fees or penalties.
However, if the borrower fails to repay the loan, the protocol may initiate a liquidation process, where the collateral is sold to recover the losses. This helps maintain the protocol’s solvency and ensures that lenders are protected.
Essential Terms for Navigating DeFi Borrowing: A User’s Guide
Now that you understand the core mechanics of DeFi lending, let’s delve deeper into some key terms you’ll encounter when exploring borrowing opportunities.
1). Interest Rate (Floating or Fixed)
What it is: The interest rate represents the cost of borrowing money. In DeFi lending, interest rates can be either fixed or floating.
How it works:
- Fixed-rate loans: The interest rate is locked in at the beginning of the loan term and remains constant throughout. This allows for easier budgeting as you know exactly how much interest your loan will accrue. These loans offer predictability and stability.
- Floating-rate loans: The interest rate is determined by supply and demand within the lending pool and can change in real-time. When there’s high demand for loans and low liquidity, interest rates tend to rise. Conversely, when there’s an abundance of funds in the pool, interest rates may decrease. These loans offer more flexibility but come with the risk of fluctuating interest rates.
Choosing between Fixed and Floating Rates: The best option for you depends on your risk tolerance and financial goals. If you prioritize predictability and stability, fixed-rate loans might be a better choice. However, if you’re comfortable with some level of volatility and potentially lower initial interest rates, floating-rate loans could be an option to explore.
2). Loan-to-Value Ratio (LTV) (aka Collateral Factor)
What it is: The Loan-to-Value (LTV) ratio is a crucial concept in DeFi borrowing. It signifies the maximum amount you can borrow compared to the value of your collateral.
How it works: DeFi lending protocols typically require collateral to mitigate the risk of defaults. The LTV sets a limit on how much you can borrow relative to the value of your collateral deposit. For example, if a protocol has a 50% LTV for an asset, you can borrow up to $50 worth of that asset for every $100 worth of collateral you provide.
Importance of LTV: LTVs play a vital role in maintaining the stability of DeFi lending pools. By requiring sufficient collateral, they ensure that even if some borrowers default, there’s enough value to cover their outstanding loans. This helps protect lenders from losses.
3). Liquidation Threshold
What it is: The liquidation threshold represents the LTV at which your collateral will be liquidated.
How it works: Smart contracts continuously monitor the value of your collateral relative to your outstanding loan. If the value of your collateral falls below the predetermined liquidation threshold (likely due to price fluctuations), the smart contract automatically sells your collateral and uses the proceeds to repay your loan.
Understanding liquidation risk: Liquidation is a major risk associated with DeFi borrowing. If your collateral’s value dips below the liquidation threshold, you could lose your collateral to repay the loan. To avoid this scenario, it’s crucial to maintain a healthy LTV ratio throughout the loan term. This might involve adding more collateral or repaying some of your loan if the value of your collateral declines significantly.
4). Liquidation Penalty
What it is: A liquidation penalty is an additional fee charged on top of the outstanding loan amount in the event of a liquidation.
How it works: Not all DeFi protocols impose liquidation penalties, but some do. These penalties serve as an additional deterrent against defaults and help generate revenue for the protocol. The specific penalty amount varies depending on the protocol.
Minimizing Liquidation Penalties: While some protocols may not have liquidation penalties, it’s always wise to factor this potential cost into your calculations. Maintaining a healthy LTV ratio and closely monitoring market fluctuations can help you avoid liquidation altogether.
5). Total Supplied and Total Borrowed
What it is: These terms represent the total amount of cryptocurrency deposited into a lending pool (total supplied) and the total amount borrowed from the pool (total borrowed).
How it works: Total supplied and total borrowed provide valuable insights into the health and liquidity of a DeFi lending pool. A healthy pool should have a reasonable balance between these two values. The amount of total borrowed relative to the amount of total supplied is typically referred to as the utilization ratio. A low utilization ratio indicates ample liquidity, potentially leading to lower interest rates for borrowers. Conversely, a high utilization ratio signifies limited liquidity and potentially higher borrowing interest rates.
Utilizing Total Supplied and Borrowed Data: By monitoring these metrics, you can make informed decisions when choosing a DeFi lending protocol. Pools with sufficient liquidity (low utilization ratio) might offer more favorable borrowing terms, including lower interest rates.
By understanding these key terms and their workings, you can understand howDeFi lending platforms work and can make informed decisions about their lending and borrowing strategies. To learn more, check out this comprehensive guide.
What is Rocko and How Can it be Used to Get a DeFi Loan?
As we’ve explored the world of DeFi lending, you may be wondering how to navigate the complexities of borrowing and lending in this new frontier. That’s where Rocko comes in as a user-friendly platform designed to streamline your DeFi borrowing experience.
What is Rocko?
Rocko is a new platform that enables users to easily get loans from popular DeFi protocols. By providing a seamless and intuitive interface, Rocko aims to increase access to DeFi lending, making it easier for users to participate in the ecosystem and get liquidity of their crypto assets without having to sell.
How Can Rocko be Used to Get a DeFi Loan?
Rocko offers a simplified borrowing process, allowing users to easily navigate the DeFi lending landscape. Here’s how Rocko can be used to get a DeFi loan:
- Set up a loan with selected assets, amounts, and the lending protocol quickly via a web dashboard.
- Link your Coinbase to easily fund and receive loans without prior DeFi experience needed. Or if you don’t have a Coinbase account, use your Ethereum wallet or other exchange account.
- Monitor loans and utilization levels to avoid liquidation through a real-time value tracking system.
Benefits of Using Rocko
Rocko platform offers users a wide variety of benefits, including:
- Ease of Use: Rocko’s user-friendly interface simplifies the DeFi lending process, making it accessible to a broader audience.
- Flexibility: Rocko offers a range of loan terms and options, allowing users to customize their borrowing experience.
- Security: Rocko’s decentralized architecture ensures that users maintain control over their assets, providing an additional layer of security.
As you can see, Rocko can be a valuable DeFi companion, simplifying the process and equipping you with the knowledge and tools to make informed borrowing decisions.
Join the Rocko waitlist today and unlock the potential of DeFi borrowing!
