Lending Protocol

A lending protocol is a DeFi protocol that allows users to supply cryptoassets to lending markets and borrow assets under rules enforced by smart contracts. The system manages deposits, debt, interest rates, collateral, and liquidation according to predefined parameters.

A typical protocol maintains a shared reserve of an asset. A liquidity provider deposits that asset and earns interest. A borrower supplies collateral and can borrow assets from the available reserve.

Most lending systems use overcollateralization. The borrower must provide collateral worth more than the borrowed amount because the protocol generally does not have a traditional credit-scoring or debt-collection mechanism.

Interest rates often depend on utilization. When only a small portion of a reserve is borrowed, rates can be relatively low. As utilization increases, rates can rise to attract additional liquidity and discourage excessive borrowing.

A lending protocol also requires liquidation rules. If collateral value falls and the position becomes insufficiently protected, third parties may be allowed to repay debt and receive collateral according to the protocol rules.

Major risks include collateral volatility, smart-contract bugs, price-oracle failures, liquidity shortages, and extreme market conditions. TVL and interest rates alone are not sufficient measures of protocol safety.