A lending protocol is a platform where users can lend and borrow crypto assets without a centralized authority, such as a bank, serving as the intermediary. The decentralized finance (DeFi) protocol relies on smart contracts to enable the full automation of lending and borrowing processes and also determines interest rates and collateral conditions.
Lending protocols allow lenders, i.e., users who provide the assets, to earn interest. At the same time, users borrowing the funds are required to provide collateral, typically in the form of cryptocurrency. For instance, a user depositing ETH will earn interest, while the borrower will need to lock collateral to access funds.
As with traditional lending systems, lending protocols may set collateral requirements higher, thus reducing the risks associated with borrowers defaulting. That said, users should always be aware of the potential drop in prices that could result in the liquidation of the collateral.
