A Simple Guide to DeFi Lending
The DeFi space comprises of several verticals, and lending is perhaps the most important one. This guide will help to give you a grasp of the core ideas behind DeFi lending, what makes it so important and why Minterest is set to raise the bar in this rapidly growing area of finance.
DeFi Lending vs. Traditional Lending
To get a clear view of why the adoption of DeFi is growing at such a pace, we need to understand the benefits it offers over traditional lending. A loan is a financial tool that’s available in both the traditional and crypto financial ecosystem, DeFi loans however, are substantially different in nature than those issued by banks.
When an individual wants to borrow money from a traditional bank, they have to go through an array of checks and meet a set of criteria imposed by the bank to qualify for a loan. The process can take over a week and an approval is not always secured. In contrast, an individual looking to borrow from a DeFi protocol only has to meet one requirement – they need enough crypto assets to overcollateralise their loan, and the transaction can be completed in minutes. Additionally, the fees for a short-term loan in traditional banks are very high compared to a DeFi loan.
Instead of the loan funds being deposited into your account by a bank, a loan on a DeFi protocol is provided by users who have staked their crypto, and in return for this, they enjoy an annual percentage yield (APY).
The ease and cost of acquiring a loan on a DeFi protocol is why the DeFi industry has seen such explosive growth in the last 2 years, with $50.63 billion in total value locked.
Why DeFi loans are attractive
- A trader can increase their holdings in their portfolio without affecting other assets.
- Interest rates for the borrowers are lower than those offered by traditional financial institutions.
- There are significantly higher APYs on the supply side for lenders.
- The fees are lower for borrowers
- DeFi users can leverage lending to provide more liquidity for complex staking and yield farming strategies.
The Challenges Facing DeFi’s incumbent lending protocols
Currently, there are 142 lending protocols distributed across several blockchains. The borrowing volume has soared 58.36% since the last year — from $16.69 billion in May 2021 to $26.43 billion today. However, DeFi lending in its current form is far from being perfect, as the industry faces some critical pain points.
External liquidators are third-party actors that earn fees for undertaking the buy-out of under-collateralised loans at discounts to market rates. The participation of external liquidators helps maintain the overall solvency of the protocol.
The Maker protocol, one of the first stable coin issuers, first introduced the practice of third-party liquidation. Any user could participate in an incentive-driven auction to bid for the liquidation. Many protocols followed the same processes, resulting in a substantial loss of value for users.
Lack of Risk Assessment Tools
Regardless of the platform, users need a way to structure products which can help offset or mitigate risk factors related to DeFi lending.
Risk management is essential, but existing protocols do not provide tools to analyze and mitigate risks. As a result, many borrowers suffer auto-liquidations, which could have been avoided with a simple analysis of their collateral and a timely reaction.
No Value Accrual from the Protocol
Some DeFi protocols are extraordinarily effective and have large TVL within their ecosystems. However, their token value is not correlated with the rising TVL because third parties remove the value generated within the protocol.
Such protocols lose the lion’s share in liquidation and interest fees generated, and this affects the token’s price.
Standard Emissions & Linear Rewards Structure
DeFi protocols issue native tokens and incentivise users with emission rewards for providing liquidity. The same tokens are used to encourage borrowing activity and these two activities shape any DeFi protocol’s APY.
However, existing DeFi protocols do not correlate lending liquidity, borrowing, and the native platform token. This results in APY lowering over time, as the number of users grows.
Minterest has identified existing DeFi lending challenges and has built a next-generation protocol that solves the issues highlighted above.
Minterest has built its own on-chain liquidation process. This feature retains up to 40% of the protocol value usually lost by other DeFi protocols.
The on-chain Treasury captures 100% of the interest rate fees and auto liquidation fees and then passes these rewards back to the users. This process boosts the total APY for all users.
Risk Assessment Tools
Minterest users will have access to an intuitive set of risk assessment tools on the Minterest Dashboard which will assist them to identify common DeFi lending risks and take action to mitigate them. Users can track data related to their positions in the protocol and activate liquidation reminders, and get notifications via Telegram, Discord, or email. This means users may significantly minimize the risk of being liquidated.
Value Accrual & Buyback
All the interest and on-chain liquidation fees are collected by the Minterest Treasury which buys back MNT tokens from the market and distributes them back to token holders. Such action generates a strong flywheel effect, as more users want to bring extra supply on-board, get more powerful buyback, and earn higher yields. Moreover, the Minterest emission structure incentivises users to adopt a long term strategy through extra rewards for loyalty.
Unlike other DeFi protocols that only focus on liquidity-based incentives and borrowing, Minterest uses a special emission structure that is allocated via three buckets.
- Standard Emission: 30M MNT tokens (60%) of the total Emissions Rewards pool is allocated equally over 5 years to liquidity providers who lend and borrow.
- Boost Emission: 15M MNT tokens (30%) of the total Emissions Rewards pool is the maximum possible allocation over 5 years to liquidity providers who hold Minterest NFTs. Boost Emission is issued in proportion to Emission Rewards, i.e. an NFT with a 30% boost in emission results in the user receiving a 30% boost in their specific amount of Emission Rewards.
- Buyback Emission: 5M MNT tokens (10%) of the total Emissions Rewards pool is the maximum possible allocation over 5 years to bootstrap the Buyback process. The Buyback Emission pool acts as a short-term subsidy of the protocol’s Buyback process, incentivising early staking of MNT tokens in supporting a more attractive APY from launch, than it would have otherwise been the case.
The adoption of DeFi lending protocols will continue to grow, especially as more crypto enthusiasts enter the market and provide the network effect that will, and is, driving the market. As liquidity grows, so will opportunities for market participants who traditionally use more passive assets to balance their investment strategies. Minterest and its unique features like auto-liquidation, buyback, and emission structure stand at the forefront of a vast, DeFi lending market.
Minterest is a unique borrowing/lending protocol built by industry leaders to service the billions in Total Value Locked (TVL), in DeFi lending projects, with the specific aim of putting user benefits at its core. It provides users with a decentralised financial platform that is fair and inclusive.
The Minterest protocol has the world’s first buyback mechanism, which automatically passes on surpluses to participating platform users. This way, users get protocol rewards on top of industry leading borrowing/lending rates, creating the potential for the highest long-term yields in DeFi. The protocol also has an on-chain treasury which captures and passes on liquidation surpluses to users.
10, May 2022