DeFi is an acronym for decentralized finance and it involves those types of financial activities that are based on blockchain. They are typically free from centralized authorities which are common in centralized finance and traditional finance.
What is DeFi Lending?
DeFi lending is a type of decentralized financial activity that involves lending funds to people. This acts as a bridge between borrowers and lenders of funds.
Typically, they are trustless and free from centralized authorities. Those that have idle funds can decide to lend them out to others to earn an interest rate.
This type of protocol tends to offer borrowers access to crypto loans in a trustless manner. Typically, those that have idle funds can decide to inject them into liquidity pools for a period to earn returns. They are given a percentage of the interest earned.
This type of platform is controlled by smart contracts, which are lined with code that ensure that users can inject funds and others can borrow funds.
Smart contracts control the operation of a DeFi lending platform. They ensure that borrowers can access loans, collect the interest rates and give them to lenders. Everything is done without the interference of centralized authorities.
Types of Lending: Collateral vs Flash Loans
DeFi lending platforms may be collateralized or flash loans. By collateralized loans, the borrower has to input a certain amount of funds as collateral before they can access the crypto loan. As for flash loans, the user is not expected to offer any funds as collateral. This is because the taking of the loan, usage of the loan, and payment are done in one transaction. If the borrower is unable to pay the loan, the entire process is reversed.
It does not matter the type of DeFi lending platform that it is, lenders or liquidity providers are rewarded with a percentage of interest rate, which is calculated using APY
Why are They Risky
Compromised Private keys are very common in users who do not safeguard their passwords and keys.
Lending protocols are risky for novice users as they are easy targets of several types of attacks such as frontrunning. These attacks have drained several users and left them with empty wallets.\
Similarly Flash Loans are used by attackers to drain funds from defi protocols.
Faulty smart contracts are also one of the most common risks as attackers bypass them through in built loopholes.
Ponzi Schemes are also notorious for looting novice and unsuspecting users through lucrative schemes.