In DeFi, lending and borrowing happen through smart contracts rather than banks. People who want to earn can deposit crypto into a lending protocol, making it available for others to borrow. Borrowers, in turn, take out loans by locking up their own crypto as collateral.
The use of collateral is central. Because there is no credit check, borrowers typically must deposit more value than they borrow, a setup called overcollateralization. If the value of the collateral falls too far, it can be automatically sold, or liquidated, to repay the loan.
These systems run on code, which brings both openness and risk. Smart contracts can contain flaws, interest rates can change, and sharp price moves can trigger liquidations. This entry explains how the mechanism works; it is educational and not a recommendation to lend or borrow.
Frequently Asked Questions
Why do DeFi borrowers need collateral?
Because there is no credit check, borrowers usually must lock up more value than they borrow. This collateral protects the protocol and can be sold if its value falls too far.
What is a liquidation in DeFi lending?
If a borrower collateral drops below a required level, the protocol can automatically sell it to repay the loan. Sharp price moves can trigger this, causing a real loss.
