LENDING AND BORROWING MARKETS are vital to the economy, providing individuals, businesses and governments with access to capital for investments, expansions and innovative projects. Without borrowing, economic growth would be severely limited; and without lending facilities, there would be no borrowing.
As a digital value management tool, the blockchain is often considered to be the financial infrastructure for the digital economy. Unsurprisingly, lending and borrowing markets have emerged within this ecosystem and evolved through several stages. Initially, centralized services led by trading platforms dominated the market, followed by the development of decentralized solutions that use the blockchain’s ability to execute code.
In a recent paper, we explored how incentive programs being offered by lending protocols to attract users are impacting the parameters and volumes of deposits and loans, as well as potential externalities in the market. In this article we will summarize our findings.
Decentralized Lending: A Primer
Decentralized lending encompasses two primary application types:
1. Liquidity pool-based applications. Protocols like Compound permit users to deposit assets into a pool and receive receipt tokens that represent their claim. Borrowers can access the pool by committing another coin as collateral and repay loans plus accrued interest.
2. Minting protocols. Protocols like MakerDAO enable users to create specific tokens through collateralized debt positions. Such protocols do not rely on third-party liquidity — and were not the focus of our work.
Collateralized lending is fundamental to the first generation of DeFi lending protocols, as pseudonymous accounts necessitate collateral for securing loans. Some projects, like , have recently begun offering under-collateralized loans by verifying institutional borrowers and linking their identities to wallets. These systems are a niche and
