As we all know, in traditional lending markets, if we want to borrow a loan from a bank, we need to provide certain physical assets as collateral. The bank will then evaluate and approve the assets before finally disbursing the loan. In the world of DeFi, the lending process is the same, except the role of the bank is removed and replaced by smart contract programs written in code.

Below, we’ll use MakerDAO, a leading project in the current market, as an example to explain the collateralized lending process in DeFi in detail.

Before diving in, we need to understand two key concepts:
The first is DAI. Think of DAI as the US dollar in the cryptocurrency world—it can be exchanged 1:1 with the US dollar.

The second concept is MKR. MKR is the cryptocurrency issued by the MakerDAO project. It serves two purposes:

1. Voting in community governance. Since the platform is decentralized, every user holding MKR can participate in the platform’s development. Any changes to the rules are decided through voting.

2. Acting as an interest token. If you borrow from the MakerDAO platform, you need to pay a certain amount of MKR as loan interest.

Once we understand these two concepts, we can get to the main topic. MakerDAO’s smart contract includes two pools: one is called the Ether Pool, and the other is the Collateralized Debt Positions (CDP).

If you want to borrow on DeFi, the first step is to provide a certain amount of digital assets as collateral (such as ETH, WBTC, USDC, or other Ethereum-based cryptocurrencies). You need to deposit your ETH or other collateral into the first pool, the Ether Pool. The smart contract will then evaluate your digital assets and return a certain amount of PETH as proof of collateral.

The second step is to take this PETH and deposit it into the second pool, the CDP, to borrow. During this process, the CDP generates debt proportional to your collateral while locking your deposited digital assets. Once the smart contract approves, it will immediately release the loan—DAI stablecoin—which you can then exchange for fiat currency on the market and spend as you wish.

When you’re done using the money and want to reclaim your digital assets, you proceed to the third step. You need to purchase a certain amount of MKR on the market as loan interest, then return both the MKR and the borrowed DAI to the CDP pool. The locked collateral will then be released, and you can retrieve your original digital assets (e.g., ETH) by sending a transaction through the smart contract. This completes the entire lending process.

Of course, if you borrow DAI but genuinely can’t repay it, you don’t have to. The smart contract will automatically auction off your Ethereum on the market to complete the liquidation process.

In summary, DeFi lending has unique advantages compared to traditional lending. Processes like asset valuation, loan approval, and fund disbursement are all executed by code, making it fairer, more secure, and more time-efficient. Currently, DeFi lending is rapidly growing, scaling from millions of dollars in its early days to tens of billions today. Let’s hope it brings us even bigger surprises in the future!