In the traditional financial market, if you want to get a loan, you need to go to a bank or other financial institution and provide Qualifying collateral is required to obtain a loan. For example, in the case of a home loan, the collateral is the equity in the house itself. Users need to pay interest and a portion of the principal to the borrower regularly until the principal is repaid in full. In traditional markets, liquidity generally comes from deposits of financial institutions, financial bonds, etc.

In the DeFi market without centralized financial institutions, all this is performed by smart contracts. However, the logic of lending transactions in the DeFi market is consistent with that in the traditional market: borrowers lend crypto assets and pay interest, and lenders lend crypto assets to provide liquidity to earn interest.

What is DeFi? What is a smart contract? Please refer to the "What is DeFi" and "What are smart contracts" chapters.

Normally, borrowers are required to provide crypto assets in excess of the borrowed amount as collateral. Because in the DeFi market, the price of crypto assets fluctuates greatly, and the value of collateral may drop significantly or the value of the loan may rise significantly, resulting in insolvency. Therefore, risk control becomes particularly important, and decentralized lending protocols often liquidate users’ collateral before it becomes insolvent.

Want to learn more about decentralized lending protocols in the DeFi market? Please refer to the "What is Aave" chapter.

Compared with traditional financial lending, lending in the crypto market has obvious flexibility. Borrowers do not need to go through cumbersome KYC and credit checks to obtain loans. There are no restrictions on the specific use of the loan - in the traditional market, home loans can only be used to purchase home equity.