Decentralized Lending: Pros and Cons
Decentralized lending is one of the main DeFi functions. While many people consider it an alternative to getting a loan from a bank, it is not completely correct. While decentralized lending and borrowing offer a lot of benefits, they cannot or rather shall not be used as an equivalent to lending in a bank.
Lending Pools and the Lending Mechanism
Decentralized lending is based on lending pools. Users who have free coins can lock them in pools. Those who need a loan can get it from a pool at a certain interest rate. To ensure they are going to repay the loan, they leave collateral.
Decentralized loans are normally over-collateralized. For example, if you want to get an equivalent of 1,000 USD in, say, DOGE, you will need to leave collateral whose value is more than 1,000 USD. Such collaterals are normally taken in cryptocurrency that is more stable or more popular than the coins given as a loan. For example, BTC, ETH, or BNB can be used as collateral to get a loan in the platform’s native tokens. It is done to ensure that any volatility risks are covered and the lender won’t suffer losses.
What happens if the collateral value drops and the value of the indeed tokens grows? There shall always be a margin between the lent funds and the collateral. Say, the lending platform has a margin of 10%. It means that if you want to borrow a 1,000 USD equivalent of a token, you need to leave a 1,100 USD equivalent in, say, ETH as collateral.
If the ETH price drops, the margin drops, too. Then, your collateral will be liquidated - sold to any user willing to buy your coins and cover your debt. The same will happen if the token value grows, and thus, your debt equivalent will become higher than 1,000 USD.
Who Uses the Decentralized Lending Services?
You may be wondering what is the logic of taking a loan if you have to leave more money as collateral than you actually get.
This is the main difference between decentralized lending from getting a loan from a bank. Decentralized lending services are normally not used to purchase a thing, to pay something, or just to manage to survive until you get your salary.
Such services are used by traders. If you have ETH but don’t want to sell it, you can borrow another coin, trade it successfully, and then, replay your debt and get your ETH back. If the operation is successful, you get your profit, and you don’t have to sell your valuable ETH.
Such loans are not taken for a long time because the interests are not low, and the sums involved are very high. Usually, decentralized lending services are used for trading big sums. A trader gets a loan, swaps the coins for profit on another platform, and relays the loan within a couple of seconds or minutes.
Decentralized Lending Pros and Cons
Decentralized lending has its benefits and drawbacks, and to use the service properly, you need to understand them.
Pros
It is decentralized, you deal directly with another user via a DeFi platform. Thus, you don’t pay any fees to a bank. Neither you need to collect any papers to get the loan.
It is accessible to anybody. It doesn’t matter in which location you are, you can use it if you have a DeFi wallet and funds to leave collateral.
Transparency is another benefit. Everything is predetermined by a smart contract. All conditions are clear and understandable. All operations are recorded on a blockchain and available to view at any time.
You can get a loan instantly, without waiting days or weeks for its approval. It enables you to benefit from profitable market conditions immediately.
Cons
Fees are not low. Be ready to pay for any move made on a blockchain. Every transaction costs, and if the platform selected by you runs on the Ethereum blockchain, gas fees can be pretty high.
Overcollateralization is another obstacle to getting a decentralized loan. If you want to use DeFi for getting some funds, be ready to leave even more funds there as collateral.
High volatility is another challenge. The price movements are drastic and unpredictable, and thus, the collateral value may drop rapidly. It impacts the margin, and if it drops below the value established by the platform, your loan may be liquidated. In such a case, you lose the collateral.
Hacks are another issue of DeFi. The sector is not regulated, and thus, users can rely only on the fairness and good will of those who are behind the platform.
DeFi is still immature, the technology is prone to vulnerabilities. Mistakes happen, and sometimes, users’ funds are involved.
That’s why if you decide to lend with DeFi, it is important to select a proper platform with some experience and reputation. Aave is one of them
What Is Aave?
Aave is a native token behind a DeFi lending protocol that runs on the Ethereum blockchain. Aave was launched in 2017 as ETHLend, and since then, it has provided reliable lending and borrowing services to crypto users all around the world.
Aave’s Price History
The project was launched in 2017 and raised in its ICO $16.2mln. The coin was sold at a rate of $0.01 per token.
In 2020, Aave became the fourth-largest DeFi protocol based on the total value locked (TVL). The token price was about $50 in October 2020, and it climbed to $87 by the end of the year. In February 2021, 1 Aave was already worth $506. The protocol became the second-largest DeFi platform based on the TVL.
When the crypto winter started, Aave suffered significant losses, like any other protocol out there. The token price was dropping with short recoveries.
As for December 2022, the token is traded at the price of approximately 65 USD.
Aave Price Prediction for 2024-2025
2024 isn’t going to be kind to Aave, based on the forecasts from TradingBeast and WalletInvestor. They believe that the token value will fluctuate somewhere around $37 to $70 but won’t cross the mark of $80.
DigitalCoinPrice believes though that the Aave value will climb to at least $180 and will cross the mark of $260 by 2025.
Aave Price Prediction for 2026-2027
Most specialists agree that in the long-term, Aave may be not the best option for investing. By 2027, the Aave glory is going to decline, and thus, the price of the token will start dropping. It may be connected with further DeFi development and the creation of new solutions that will be much faster, more efficient, and safer than the existing ones.
Conclusion
Decentralized lending is still very limited in use due to many factors. Moreover, it is not suitable for ordinary users who want to get some funds for traditional needs such as making purchases, etc. This is why DeFi is mostly used by traders to make a quick profit.
Aave is one of the major lending protocols out there. For now, it is developing rapidly but it is expected that in the future, other applications may be developed that will be faster, safer, and in general more efficient than Aave. Therefore, this token may not be the best option for long-term investment.
Stay tuned for further updates, crypto guides, and market insights from LetsExchange. You can also follow us on Twitter, Facebook, Reddit, Instagram, LinkedIn, Medium, Quora, Telegram, Steemit, and Bitcointalk for first-hand information from our team.