Crypto lending is a $36B market and the bedrock for much of the DeFi activity that takes place onchain 24/7. Despite decentralized lending being scarcely three years old, it’s ossified into a sector that anchors a host of economic activity across EVM and non-EVM chains.
The basic design of DeFi lending protocols hasn’t materially changed since its inception: a user typically deposits one asset, such as ETH, and borrows a second asset such as a stablecoin in return. The deposited asset serves as collateral and can be withdrawn in full at any time upon repayment of the loan. This tried-and-tested formula has propelled DeFi into a multi-billion dollar industry.
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But while the fundamental mechanisms underpinning crypto lending remain largely the same, there’s been significant innovation elsewhere. Specifically, the type of assets that can be used as collateral has expanded greatly – and so has the way in which collateral management is handled. These changes have quietly transformed lending into one of the most innovative verticals in DeFi today.
Greater Collateral for DeFi Borrowers
Traditionally, borrowers have been able to obtain a loan of up to 50% of the value of their staked collateral. Any more than this and they risk liquidation should the value of their deposited assets fall in price. While this provision is sensible from the perspective of maintaining a healthy lending to borrowing ratio, it’s extremely capital inefficient. Borrowers are forced to heavily over-collateralize, which minimizes the amount of capital they can obtain for use elsewhere in DeFi.
But this borrowing threshold, once thought to be immovable, is no longer set in stone. One of the protocols spearheading a transformation in borrowing limits is Nolus, whose lending platform has processed more than $50M since launching in June 2023. Around 10,000 users are currently providing $5M in TVL to the protocol, having been lured there by the promise of more capital-efficient borrowing.
Nolus allows borrowers to triple their available capital without a commensurate increase in risk. As a result, up to 150% financing is available through leveraged lending. This is achieved by locking a down payment in the form of fiat, stablecoin, or digital asset into the protocol. Both the staked asset and the loan are then used to purchase the desired asset. With the down payment and the loan locked into a DeFi Lease position, the combined collateral reduces the risk of margin call risk by 40% compared to other lenders.
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Nolus also utilizes partial rather than full liquidations (which is the industry norm), ensuring that even if a position becomes under-collateralized, the user has time to top up their position and avoid further liquidation. It’s a novel approach to DeFi lending that provides greater scope for deploying maximum available capital and reaping the rewards.
Off-Chain Assets as Collateral
Another area in which DeFi lending has evolved greatly is in terms of the sort of assets that can be used as collateral. For a long time, this was limited to digital assets such as ETH and stablecoins. One drawback to this is that it limits institutional participation in particular, since enterprises hold most of their assets off-chain in things like cash, T-bills, and other real-world assets (RWAs).
But the emergence of protocols that can accept RWAs as collateral has changed this dynamic, allowing off-chain cash equivalents such as shares and repurchase agreements to be used as collateral. Protocols such as MakerDAO, Frax Finance, and Aave have all introduced RWAs using third parties to oversee their custody.
Through the tokenization of RWAs, the range of assets that can be used as DeFi collateral has also expanded. It’s now possible to use once illiquid real-world assets such as precious metals, fine art, wine, and real estate to obtain onchain loans. If it’s got value and is relatively stable, there’s a DeFi protocol out there willing to tokenize it and offer stablecoins in return. This allows consumers and institutions to take advantage of onchain opportunities without needing to liquidate their RWAs.
Cross-Chain Lending Arrives
As the number of Layer 1 and 2 blockchains has exploded, the days of doing everything on one chain have rescinded. It’s now routine for DeFi users to move assets between EVM and non-EVM chains in search of the greatest economic opportunities.
For a long time, a borrower would need to bridge their assets to another chain and be mindful of their liquidation threshold. Should their collateral value drop sharply, as can happen during times of market volatility, the user faces a race against time to bridge their assets back to the original chain and top up their position.
The emergence of cross-chain lending has simplified this. Now, users can deposit funds on one chain and borrow on another by taking advantage of multi-chain lending protocols. This solution provides greater capital efficiency and enhances liquidity, which can flow effortlessly to where it can be most effectively deployed.
Lending remains a primary driver of DeFi activity and is one of the main ways in which onchain users can put their assets to work while capitalizing on the upside to holding a deposited asset such as ETH. But thanks to the emergence of new lending products that facilitate greater borrowing limits, a wider choice of collateral, and cross-chain borrowing, the lending sector has evolved in leaps and bounds. Today, it remains one of the most vital and creative sectors in DeFi, underpinning much of the trading and liquidity mining that makes decentralized finance so attractive to so many.
