DeFi Lending Explained: A Beginner’s Guide to Borrowing and Lending

DeFi lending runs on smart contracts that match people who want to earn yield on their crypto with others who need liquidity. You supply tokens to a pool, borrowers take from that pool and pay interest, and the contract handles repayment and collateral automatically.

How a Lending Pool Actually Works

Take a platform like Compound. When you deposit 1,000 USDC, the contract mints cUSDC tokens that represent your share. That share grows as borrowers pay interest back into the pool. No one approves your deposit manually; the rate adjusts every block based on supply and demand.

• Supply USDC and receive interest-bearing tokens immediately.
• Borrowers post ETH or other assets as collateral, usually at 150 percent or higher of the loan value.
• If collateral value drops, the contract lets anyone liquidate the position to protect lenders.

Borrowing Steps With Real Numbers

Suppose ETH sits at $2,500 and you want $1,000 in USDC. You deposit 1 ETH as collateral. Most protocols let you borrow up to 60-70 percent of that value, so roughly $1,500 max. You pull $1,000 USDC, pay a variable rate that might sit at 4-8 percent APR depending on pool usage, and can repay anytime by sending the USDC back plus accrued interest.

1. Connect a wallet that holds the collateral asset.
2. Approve the smart contract to move your tokens.
3. Choose the borrow asset and amount; the contract checks your collateral ratio before releasing funds.
4. Monitor health factor; if it falls below 1.0, liquidation can occur within minutes.

Collateral and Liquidation Basics

Most users track one number: the health factor. It compares your collateral value against the borrowed amount and the liquidation threshold. Drop below 1.0 and a liquidator repays part of your debt in exchange for discounted collateral. In the May 2022 crash, many positions crossed that line within hours when ETH fell 30 percent in a day.