DeFi lending
DeFi lending is borrowing and lending through smart contracts: some users deposit crypto to earn interest, others borrow against collateral that is sold automatically if its value falls too far.
How it works
Lenders put tokens such as USDC into a shared pool and earn interest. Borrowers deposit collateral, such as ETH, and borrow from the pool. You always need more collateral than you borrow, which is called overcollateralization, because the protocol does not know who you are and cannot take you to court.
Each asset has a liquidation threshold. The protocol reads prices from an oracle and tracks a health factor. If it drops below 1, anyone can repay part of your debt and take part of your collateral at a discount. Borrow and deposit rates float with how much of the pool is in use.
Why borrow if you already have more collateral? To get stablecoins without selling your ETH, to take on leverage or to fund other strategies. The risks are liquidation in a crash, bugs in the code and oracle failures.
You deposit 1 ETH ($3,000) and borrow 1,500 USDC. Say the liquidation threshold is 80%. Health factor = 3,000 × 0.8 / 1,500 = 1.6. Liquidation starts when 0.8 × the ETH price falls to $1,500, so at about $1,875 per ETH, a 37.5% drop.
The most common mistake is borrowing the maximum and not watching the position. Crypto can fall 30% in a day, and your collateral gets sold with a penalty. Keep a wide health factor buffer, decide in advance at what price you will add collateral or repay, and remember the borrow rate can rise.
Questions and answers
How does DeFi lending work in simple terms?
You lock crypto as collateral and borrow from a shared pool against it. If the collateral loses too much value, the program sells it to repay the loan.
Why do DeFi loans need more collateral than the loan?
The protocol does no identity or credit check. The only guarantee of repayment is collateral with a buffer for price drops.
What is a health factor?
It measures how safe your position is. If it falls below 1, the position can be liquidated.
Related terms
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Updated: 2026-10-19