DeFi (decentralised finance)
Financial services (trading, lending, borrowing) run by smart contracts, without a bank or broker.
Finance without a counter
Decentralised finance covers financial services run by smart contracts: swapping tokens on a decentralised exchange, lending to earn interest, borrowing against collateral. There is no bank, no adviser and no opening hours: anyone with a wallet can use it, and everyone keeps control of their funds.
Borrowing against collateral
Lending protocols such as Aave require collateral worth more than the loan. The health factor compares the collateral, weighted by a liquidation threshold, with the debt. Below 1, part of the collateral is sold automatically to repay the lender.
- Liquidation when the factor falls below 1.
Borrowing USDC against ETH
- Deposit: 10 ETH at $3,000, i.e. $30,000 of collateral; liquidation threshold: 82.5%.
- Loan: 15,000 USDC.
- Health factor: 30,000 x 0.825 / 15,000 = 1.65.
- ETH liquidation price: 15,000 / (10 x 0.825) = $1,818, a 39% fall.
A 39% fall in ETH is enough to trigger liquidation.
Common mistakes
- Stacking yields across protocols without stacking their risks.
- Borrowing the maximum allowed: the slightest fall in collateral triggers liquidation.
Questions and answers
Is DeFi regulated?
The EU MiCA regulation targets issuers and service providers, not truly decentralised protocols. The front ends and platforms giving access to them can be covered.
What is TVL?
Total value locked in a protocol. It measures its size, but moves mechanically with the price of the tokens deposited.
Notitia newsroom · education, not investment advice.