Decentralized Lending Tokens
A buzzword that has been popping up more recently in the crypto community is DeFi (decentralized finance). Many new tokens have been created to provide lending, payment, and trading solutions through their blockchains.
One of my favorite new tokens is Compound Token. I’ve spent a fair amount of time reading over the white paper and using the ecosystem. I’m going to explain how Compound works in a slightly more general sense so you can have a better understanding of how most of these DeFi coins work.
Compound has set up an ecosystem for lenders to deposit ERC-20 tokens (Ethereum based coins) to their platform. People can borrow those assets by providing Compound tokens as collateral. The platform sets interest rates algorithmically based on the total supply of individual tokens compared to the amount demanded.
One of the main appeals of a decentralized loan on the Compound network is that assets supplied are fungible resources. This allows lenders to close their loans at any point without forcing borrowers to return their tokens.
Other benefits are for longer term crypto holders to earn interest on top of the price appreciation of their investments. Traders have the ability to short any asset on the protocol by borrowing the asset and selling it on an exchange. Traders could also finance new ICO investments using their current portfolio as collateral.
The main benefit to decentralized loans is the yields lenders can receive. Lenders can lend stablecoins (USD backed coins) and get 4% annual yields. The loan has very little risk and because the lender is using a stablecoin, they have no exchange value risk. When lenders compare whether they would like to buy treasury bonds for less than 1% yield or lending at a 4% rate with fungibility, the appeal starts to become clear.