Lending is the cornerstone of the entire DeFi world. Before understanding this logic, we need to have some knowledge about stablecoins.

Native tokens in the digital currency industry, such as Bitcoin and ETH, are highly volatile, which poses significant risks to settlement and payments. Therefore, the digital currency industry requires relatively stable currencies like the US dollar for settlement, which is why stablecoins emerged.

Stablecoins come in various types, mainly categorized into off-chain collateralized, on-chain collateralized, and non-collateralized. Non-collateralized stablecoins currently have no large-scale applications and will not be discussed here. Off-chain collateralized stablecoins are represented by Tether's USDT. For every $1 received, Tether issues 1 USDT. The issue with such tokens is that the issuing institution needs to be audited regularly to ensure it has sufficient collateral. On-chain collateralized stablecoins are represented by DAI, issued by MakerDao, which is obtained by depositing ETH into MakerDao's smart contracts.

The biggest problem with USDT lies in its centralization. First, the so-called 1:1 peg to the US dollar has never been supported by published audit reports, and this issue has been criticized for a long time. Second, the SEC is still investigating USDT. If problems are indeed found, USDT will undoubtedly experience a flash crash. USDC is similar to USDT; although it undergoes compliance audits, it still cannot escape the issue of centralization.

Therefore, on the blockchain, the decentralized stablecoin DAI is the most important and fundamental core component, and the lending protocol that produces DAI naturally becomes the cornerstone of the entire DeFi world.

Currently, the three most widely used lending projects in the DeFi space are MakerDao, Compound, and AAVE:

1. MakerDao: Its core function is to produce the stablecoin DAI through its Collateralized Debt Position (CDP) protocol. A critical parameter here is the collateral ratio, which is set at 150% in MakerDao. This means that for every $150 worth of ETH deposited, only 100 DAI can be borrowed. If the collateral ratio falls below this threshold, the system will start liquidating the CDP. If a user voluntarily closes a CDP, they must pay a fee in MakerDao's native token, MKR. The paid MKR is burned by the smart contract, indirectly achieving MKR deflation and driving up its price. Therefore, we can observe that when USDT was exposed to SEC investigations, the supply of DAI increased, meaning more CDPs were created. More CDP creations also imply that more users will close their CDPs (note that the creation and closing of CDPs is a dynamic equilibrium process), leading to more MKR being burned and its price being pushed higher. Essentially, as long as the demand for DAI increases and MakerDao operates healthily, the price of MKR will inevitably rise.

2. Compound: Simply put, Compound establishes numerous liquidity pools, each corresponding to a specific token. Users can deposit assets to earn interest or borrow assets by paying interest, with rates adjusted in real-time by algorithms, reflecting market-driven interest rates. A key detail is that the value of deposited assets determines the amount that can be borrowed, and different assets have different borrowing coefficients—the higher the coefficient, the more can be borrowed. Compound's true breakthrough was being the first in DeFi to introduce liquidity mining, leading to explosive growth in its Total Value Locked (TVL). This growth drives its deposit and lending rates closer to reasonable levels, attracting users with funding needs to trade on Compound and further propelling ecosystem development.

3. AAVE: Its logic is broadly similar to Compound. Originally named ETHLend, it was one of the early lending projects on Ethereum. Its most notable feature is the flash loan functionality. Flash loans are an extremely geeky and disruptive innovation unique to blockchains. To understand flash loans, one must understand blocks. Transactions on the blockchain are packaged into blocks, and a flash loan involves borrowing and repaying within the same block (if only borrowing occurs without repayment, the entire transaction is not included in the block, resulting in failure). No collateral is required for this. Theoretically, flash loans eliminate dependence on capital, unleashing the power of strategies. In principle, as long as a strategy is sound, there's no need to worry about funding sources—the blockchain could be filled with unlimited free capital. On Aave, 17 tokens support flash loans, with a fee of 0.09%.
   AAVE Official Homepage

Lending platforms offer several strategies:

First, simply depositing assets to earn interest, which is highly attractive to users with large idle assets while increasing liquidity in the platform's pools.

Second, leveraging. For example, if bullish on ETH, a user can use DAI to buy ETH, deposit the ETH into the lending platform to borrow more DAI, and then use the borrowed DAI to buy more ETH, repeating the cycle.

Third, shorting. Users can deposit DAI to borrow ETH, sell the ETH, and then repurchase ETH at a lower price to repay the loan, profiting from the price difference.

Conclusion

Lending is the foundation of DeFi. While many average users may not directly use lending applications, the towering edifice of DeFi is built step by step starting with lending. If lending protocols fail, the entire structure will crumble. Therefore, to truly find wealth in the DeFi industry, one must understand lending. People can never earn money beyond their knowledge—we must keep our eyes on the road ahead.