The blockchain industry has had tremendous success in the past decade. According to Coin Market Cap, the valuation of all digital currencies has soared to more than $1.5 trillion, led by Bitcoin. Decentralized Finance (DeFi), a sub-sector of the industry, has also surged, with the total value locked (TVL) surging to more than $40 billion. In this article, we will look at what DeFi peer-to-peer investing and lending works.
What is DeFi?
Today, most of the financial sector is centralized, meaning that systems are controlled by a central authority. For example, in the banking sector, it is an individual bank that sets the terms of financing, including the overall interest rate. In trading, it is companies like Robinhood and Schwab that set the terms.
The DeFi industry aims to change this. The goal is to leverage the power of the blockchain industry to democratize the financial sector. For example, DEXes, a sub-sector of the industry, hopes to make it easy for people to trade and invest in a decentralized way. No one can shut the exchanges or exclude people. Most importantly, there are no borders in this industry. Similarly, the payment DeFi industry is changing how people pay for goods and services. Other popular types of DeFi are:
- Lending. As you will see later, this is an industry that makes it easy for people to borrow and lend money through blockchain.
- Derivatives. This is an industry that helps people trade several financial derivatives in a decentralized way. Examples are Synthentix and Siren.
What is peer-to-peer lending?
Peer-to-peer lending is a relatively young industry that is powered by the internet. It is a process where users borrow and lend money through a centralized platform like LendingClub and Prosper. The idea behind it is simple. The centralized company will first come up with a platform and technology to screen borrowers and lenders. It will look at things like ID documents and the credit score.
A borrower will be screened and given a rating on the platform. Therefore, if you are a lender, you will use this data to screen the customer and lend them money based on the terms suggested by the company. Your profit will be the interest they pay back.
While the centralized P2P platforms work well, there are several challenges. First, they exclude people from other countries and some states to operate within the law. Second, there is no transparency on how interest rates and other terms are set. Finally, in some instances, there is no collateral, making some of the loans risky to the investors.
DeFi peer-to-peer lending explained
The DeFi peer-to-peer lending is quite similar to the traditional P2P method offered by companies like LendingClub. The only major difference is that it is made possible by blockchain technology.
The lending sub-sector is the biggest sub-sections of the DeFi Industry. Indeed, according to DeFi Pulse, three of the biggest DeFi platforms are in the lending sector.
The process works in a relatively simple way. First, a lender will create an account with a DeFi lending platform like Maker and Aave and then deposit their fiat currencies. Second, a borrower will deposit a cryptocurrency, typically with ERC20 tokens like Binance Coin, DAI, and TrueUSD. This deposit will act as the collateral of this transaction. With the collateral deposited, the borrower will go to the marketplace and take a loan. They will then repay the loan with interest and then get their collateral back. In total, this process will take less than 30 minutes to start and complete. The chart below shows how DeFi lending works.
How DeFi lending works
The peer-to-peer DeFi lending is a win-win situation for the two sides. Furthermore, the lender will generate a return on their idle cryptocurrencies while the borrower will receive money to fund their needs. This is a highly lucrative business model that banks and other top lenders have exploited for years.
Top DeFi peer-to-peer lending platforms
There are hundreds of DeFi projects around the world. However, data compiled by DeFi Pulse shows that the biggest of these companies are in the lending sector. In total, the value locked in the lending industry is more than $17 billion, which is substantial considering that the total industry has about $40 billion.
Total value locked lending
Here are the best-known lending DeFi projects:
- Maker. The Maker protocol is the biggest decentralized lending platform with more than $6 billion in total value locked.
- Compound. It is the second biggest DeFi project with more than $5 billion in TVL and more than $12 billion of assets earning interest.
- Aave. Aave has more than $4.6 billion of TVL. It enables people to borrow and invest, as shown below.
Other popular DeFi lending projects are InstaDApp, Alpha Homora, DeFi Saver, Reflexer, and Idle Finance, among others, as shown below.
Top DeFi lending platforms
As you can see, most of the DeFi projects are built on the Ethereum network. This is what has helped the network grow so fast to become the second-biggest in the world after Bitcoin. However, other popular networks like Polkadot, Algorand, Solana, and Elrond have become rather popular recently.
Also, most platforms don’t set interest rates directly. Instead, the lending rate is determined by the supply and demand in the marketplace.
Benefits of DeFi peer-to-peer investing
There are several benefits of investing in the DeFi lending industry.
- Global. Unlike other centralized lending platforms, DeFi lending platforms are global. Anyone can borrow so long as they have the collateral.
- Decentralized. No individual has total control of the network. It is based on smart contracts technology.
- Permissionless. As mentioned, the industry is permissionless, meaning that anyone can access it.
Other top benefits for the industry are its interoperability, self-custody, and transparency, among others.
The blockchain industry is changing all aspects of our lives. For one, Bitcoin has become so important that it is now worth more than $1 trillion. If it was a company, the cryptocurrency would be the sixth-largest after Apple, Saudi Aramco, Microsoft, Amazon, and Google. Still, the DeFi industry is the fastest-growing sub-sectors and one that holds the most authority. Analysts believe that it poses the most risks to the traditional centralized industries.