Lending protocols allow you to deposit funds and receive an annual yield in return. Besides depositing, they also allow you to borrow tokens using your deposited tokens as collateral.
Many people use these applications as a way to borrow tokens for trading: They deposit — for example — ETH and borrow DAI for buying more ETH, thus owning a bigger exposure to ETH.
With lenders and borrowers in the same market, the price to borrow (i.e., the APR) increases as more tokens are borrowed.
Compared with centralized finance, there are no practical dangers associated with DeFi lending. However, like anything else, DeFi also has risks associated with it. For example, certain smart contract risks are present, and there is also the threat of APYs changing dramatically within a short time window.
For example, during the DeFi craze of 2020, where “yield farming” became the rage globally, borrowing APYs on certain cryptocurrencies rose to over 40%. Potentially, this could have caused unaware users who might not track their interest rates daily to repay more than they might have initially expected.
Simply put: In a traditional market, tomatoes get more expensive when fewer fresh vegetables are available in the winter. With lending protocols, the APY gets higher if fewer people lend tokens.
Like liquidity pools, loaning protocols focus more on lending and borrowing stablecoins against assets. While interacting with such loaning protocols, we will look to mainly invest in stable coins and achieve a smaller but safer return. Holding stables will also nullify any price volatility.
As you can see, we are constantly considering different ways to diversify and manage your treasury’s risk