Decentralized Finance (or DeFi) aims to create an open, permissionless, and transparent financial system that operates without intermediaries — unlike traditional banks. Within the DeFi space, DeFi lending protocols allow users to borrow and lend crypto assets permissionlessly among each other. These protocols also offer various benefits, such as competitive interest rates, low or no fees, transparency, and flexibility.

According to Binance Square, the total value locked in DeFi protocols has reached a new high of $42 billion in the second half of 2023 — indicating strong interest in this sector.

In this article, we will explore three of the most popular lending protocols in the DeFi ecosystem as well as several newer DeFi lending projects with the potential to capture market share.

What are DeFi Protocols, and How Do They Work?

Before looking at the best DeFi protocols, let’s first understand how DeFi protocols work.

DeFi lending protocols are decentralized applications (or dApps) that run on a blockchain network, such as Ethereum. They use smart contracts, which are self-executing codes that enforce the rules and logic of the protocol. Smart contracts enable users to interact with the protocol directly without the need for intermediaries or trusted third parties.

DeFi lending protocols typically have two types of users: suppliers and borrowers.

• Suppliers are users who deposit their crypto assets into the protocol and earn interest on them.

• Borrowers are users who take out crypto assets as loans from the protocol and pay interest on them.

DeFi interest rates are determined by the supply and demand of each asset in the protocol, as well as other factors including risk parameters, governance decisions, and market conditions. DeFi lending protocols require users to provide collateral, which is a security deposit that protects the lender from default or fraud. Collateral can be in the same asset as the loan or a different asset, depending on the needs of the borrower. Users have to maintain a certain ratio between their loan value and their collateral value in order to keep their assets from being liquidated.

What is Liquidation? Liquidation is the process where the protocol sells the user’s collateral to repay the loan. It's important for borrowers to compare liquidiation thresholds across various protocols and keep an eye on their loan health when taking out DeFi loans.

1). Compound - The Forefront of DeFi Lending

Compound is one of the largest and most well-known DeFi protocols for lending and borrowing and offers floating-interest rates for a wide range of crypto assets. Compound was founded in 2017 by Robert Leshner and Geoff Hayes with the goal of creating a decentralized protocol that allows users to earn interest on their idle crypto assets.

• Compound launched its first version in September 2018

• Compound introduced its governance token, COMP, in June 2020

• Compound launched its third version, Compound III, in August 2022

Compound III simplified its system design and focused on security, capital efficiency, and a better user experience.

Some of the Key Features of Compound Include:

1. Simplicity: Compound simplified its system design with version III to focus on security, capital efficiency, and the user experience.

2. Comptroller: Compound has a smart contract called the Comptroller that manages the risk of loans on the platform. The Comptroller determines the collateral requirements for various loans and ensures liquidations occur when necessary.

3. Oracle: Compound uses Chainlink as its oracle provider to obtain accurate and secure price data for assets across the platform. Chainlink is a decentralized oracle network that aggregates data about the prices of different assets and makes it available to various protocols.

How to Use Compound?

Here's how to get started with Compound:

• Connect your Ethereum wallet, such as MetaMask or Coinbase Wallet, to the Compound app.

• Choose an asset type to supply or borrow from the list of supported assets.

• Enter the amount you want to supply or borrow and confirm the transaction. You will see your balance and interest rate on the app.

• If you supply an asset, you can use it as collateral to borrow another asset. Inside the app, you will see your collateral factor, which indicates how much collateral you have relative to your loan.

• If you borrow an asset, you will have to pay interest on it and maintain a sufficient collateral factor to avoid liquidation. You can repay your loan and reclaim your collateral at any time through the Compound app.

Pros and Cons of Compound:

Pros

• Transparent interest rate model

• A strong track record of security and reliability

• Incentives for depositors and borrowers

Cons

• Does not offer USD/fiat loans

• Does not offer fixed-rate or flash loans

• Limited collateral assets

2). Aave - Innovating on DeFi Lending Pools

Aave is another popular DeFi lending protocol that supports a wide range of crypto assets both for supplying and borrowing. Aave was founded by Finnish entrepreneur Stani Kulechov in 2017 under the name ETHLend as one of the first decentralized lending protocols on Ethereum.

• Aave rebranded from ETHLend to Aave in September 2018

• Aave launched its mainnet in January 2020

• The Aave token (AAVE) was launched in October 2020, replacing the old LEND token

AAVE serves as a governance token that allows holders to vote on proposals and changes to the protocol. Aave introduced several innovations to the DeFi lending space and also expanded its supported assets and features over time, adding stablecoins, tokenized bitcoin, and governance tokens.

Aave offers a variety of loans including floating-rate loans and flash loans. Aave pioneered flash loans, which are a type of crypto loan that must be repaid within a single blockchain transaction block.

Some of the Key Features of Aave Include:

1. aTokens: Aave uses aTokens to represent the balance and interest of each asset supplied or borrowed on the platform. aTokens are ERC-20 tokens that accrue interest in real time and can be redeemed for the underlying asset at any time.

2. Liquidations: Aave has a useful "health factor" feature that indicates how close a user is to being liquidated. Users can monitor their health factors and take action to avoid liquidation.

3. Oracle: Like Compound, Aave uses Chainlink as its oracle provider to obtain accurate pricing data for the crypto assets on its platform.

How to Use Aave?

Here's how to get started with Aave:

• Connect your Ethereum wallet, such as MetaMask or Coinbase Wallet, to the Aave app.

• Choose an asset type to supply or borrow from the list of supported assets.

• Enter the amount you want to supply or borrow and confirm the transaction. You will see your balance and interest rate on the app.

• If you supply an asset, you will receive a corresponding aToken, which represents your balance and interest. You can redeem your aToken for the underlying asset at any time.

• If you borrow an asset, you will have to use another asset as collateral. Inside the app, you will see your health factor, which indicates how close you are to being liquidated. You can repay your loan and reclaim your collateral at any time.

Pros and Cons of Aave:

Pros

• Offers the unique flash loan type

• Supports a wide variety of collateral assets

Cons

• Offering collateral assets with less liquidity can increase lending risk

• Does not offer USD/fiat loans

3). MakerDAO - Providing Stability in Volatile Markets

MakerDAO is one of the oldest and most influential DeFi lending platforms. MakerDAO was founded in 2014 by Rune Christensen, a Danish entrepreneur and computer scientist, who envisioned a decentralized and stable currency that could be used for global trade and commerce.

• MakerDAO launched its first version in 2017

• MakerDAO upgraded to its second version in 2019

• MakerDAO migrated to its current version in 2020

MakerDAO’s current version supports over 20 collateral assets, including ERC-20 tokens, tokenized real-world assets, and synthetic assets. It enables users to mint DAI, a stablecoin pegged to the US dollar.

MakerDAO uses a two-token system: MKR and DAI. MKR is the governance token that allows holders to vote on protocol parameters and upgrades. DAI is the stablecoin that is created by locking up collateral assets in smart contracts called Vaults.

Some of the Key Features of MakerDAO Include:

• Vaults: MakerDAO uses Vaults to allow users to generate DAI by locking up collateral assets such as ETH or WBTC. Users can borrow up to a certain percentage of their collateral value, depending on the collateral type and risk parameters.

• Liquidations: MakerDAO also has a feature called "collateralization ratio" that indicates how much collateral a user has relative to their DAI debt. Users can monitor their collateralization ratio and take action to avoid liquidation.

• Oracle: MakerDAO uses its own oracle system to provide reliable price data for the platform. The MakerDAO oracle is composed of a set of trusted data feeds that submit prices on-chain and a smart contract that calculates the median of the submitted prices.

How to Use MakerDAO?

Here's how to get started with MakerDAO:

• Connect your Ethereum wallet to the Maker app.

• Create a Vault with a collateral asset, such as ETH, WBTC, USDC, etc.

• Generate DAI by borrowing the amount you want. You will pay a stability fee on your DAI debt.

• Earn interest on your DAI by depositing them in the DSR smart contract.

• Repay your DAI debt and reclaim your collateral by closing your Vault.

• Avoid liquidation by keeping a sufficient collateralization ratio. You can monitor your ratio and adjust your position accordingly.

Pros and Cons of MakerDAO:

Pros

• Has maintained the peg of DAI effectively

• Transparent governance system

• The DSR provides passive earnings for DAI holders

Cons

• Complexity in understanding Collateralized Debt Positions

• DAI may be considered more risky than a dollar-backed stablecoin

• Does not offer USD/fiat loans

Other Popular New Lending Protocols

While the three protocols mentioned above have dominated the DeFi lending space and are widely considered to be top DeFi protocols, newer DeFi platforms are making their mark.

1). Notional Finance

Notional Finance is a DeFi protocol that specializes in fixed-rate lending and borrowing for different maturities up to one year. Notional Finance uses an automated market maker (AMM) model that matches supply and demand curves for different maturities and interest rates.

It was founded in October 2020 by Jeff Wu and Teddy Woodward, two software engineers and entrepreneurs.

It is governed by the NOTE token, which gives holders voting rights.

Its popular use cases include: Borrowing cash at a predictable cost, lending crypto at a stable return, and arbitraging interest rate differences.

The key differences that separate Notional Finance from other DeFi protocols include: Offering fixed-rate loans and maturity-based pools.

2). Morpho

Morpho is a DeFi protocol that enables users to supply and borrow assets on Ethereum with increased efficiency and flexibility.

Morpho is governed by the MORPH token, which gives holders voting rights and a share of the protocol fees

Its popular use cases include: Accessing liquidity, optimizing positions, and leveraging arbitrage opportunities.

The key differences that separate Morpho from other DeFi protocols include: Its flexible and customizable lending system, its low-cost and high-performance features

Wrapping Up

The DeFi lending ecosystem continues to grow as more lending protocols launch with new value propositions. While there are risks, lending protocols also provide a great way to access liquidity without having to sell your crypto holdings. If you want to borrow cash from top DeFi protocols using your crypto quickly while easily managing your loan, check out Rocko!