Imagine needing cash but not wanting to sell the crypto you’ve been hoarding. DeFi borrowing lets you tap the value of your digital assets without a bank in sight. In this guide we’ll break down the whole process, walk through a real‑world example, and show you how to keep your position safe.
What is DeFi borrowing?
DeFi borrowing is a set of protocols that allow users to lock crypto assets as collateral and receive a loan in another token, all executed by smart contracts on a blockchain. Unlike traditional loans, there’s no credit check, no paperwork, and the rules are coded into the protocol. The most common base layer is Ethereum, which hosts the majority of borrowing platforms.
Core mechanics: collateral, over‑collateralization, and CDPs
Every DeFi loan is backed by a Collateralized Debt Position (CDP), a smart‑contract vault that holds your collateral. Because crypto prices can swing wildly, protocols require you to over‑collateralize-typically 150% or more of the loan value. This safety margin protects lenders and guarantees that the loan can be repaid even if the market dips.
When the value of your collateral falls below a predetermined threshold, the protocol triggers a Liquidation process. The collateral is sold on the open market, and the proceeds cover the outstanding debt plus a penalty fee.
Major platforms and how they price loans
Three platforms dominate the space in 2025: Aave, a liquidity‑market protocol that offers both stable and variable rates., Compound, an algorithmic money market where interest rates adjust based on supply and demand., and MakerDAO, which lets you mint the stablecoin DAI against Ethereum‑based collateral.
All three use an Interest Rate Model to set the cost of borrowing. Aave offers a choice between a fixed “stable” rate and a market‑driven “variable” rate. Compound’s rates are purely variable and change every block based on utilisation. MakerDAO’s DAI loans have a fixed stability fee that accrues per second.
| Platform | Collateral Types | Interest Rate Model | Max LTV (Loan‑to‑Value) |
|---|---|---|---|
| Aave | ETH, WBTC, USDC, many ERC‑20 tokens | Stable vs. Variable | 80% |
| Compound | ETH, USDT, USDC, DAI, COMP, others | Purely Variable | 75% |
| MakerDAO | ETH, WBTC, LINK, others (via collateral adapters) | Fixed stability fee | 66% |
Step‑by‑step example: borrowing USDC on Aave
- Connect your wallet (MetaMask, Trust Wallet, etc.) to the Aave interface.
- Deposit ETH as collateral. The UI shows the current LTV; let’s say 75%.
- Enter the amount of USDC you want to borrow. Aave will display the resulting health factor.
- Choose a stable or variable rate. For a short‑term need, the stable rate locks your cost.
- Confirm the transaction. The smart contract creates a CDP, locks your ETH, and sends USDC to your wallet.
- Monitor the health factor. If market volatility pushes it below 1.0, you’ll need to add more ETH or repay part of the loan to avoid liquidation.
This flow is identical on Compound, except you’ll see an “Supply” and “Borrow” tab instead of a single “Deposit” step. MakerDAO adds an extra step of opening a Vault and minting DAI.
Advanced use case: flash loans
A Flash Loan is a short‑lived, uncollateralized loan that must be repaid within the same transaction block. Developers use them for arbitrage, collateral swaps, or debt refinancing. Because the loan atomically settles, there’s no risk of default-if the logic fails, the whole transaction reverts.
Example: you spot a price gap where ETH trades for $1,800 on Uniswap but $1,820 on SushiSwap. A flash loan of 100 ETH from Aave lets you buy cheap ETH, sell high on SushiSwap, repay the loan plus a tiny fee, and pocket the spread-all in one block.
Risks you must watch
- Liquidation risk: Rapid price drops can trigger forced sales of your collateral.
- Smart‑contract bugs: A vulnerability could drain the CDP pool.
- Oracle manipulation: Some protocols rely on price feeds that can be spoofed.
- Interest‑rate spikes: Variable rates can surge if utilisation spikes.
Mitigation strategies include: diversifying collateral across assets, setting a health factor well above 1.5, and using reputable oracles like Chainlink.
Checklist for safe DeFi borrowing
- Pick a platform with audited contracts (Aave, Compound, MakerDAO all have multiple audits).
- Use over‑collateralization >20% beyond the minimum LTV.
- Enable price‑feed alerts (e.g., via Blocknative or DeBank).
- Keep a buffer of native token (ETH) to cover gas fees for repayments.
- Consider using a “stop‑loss” script that auto‑repays if health factor falls.
Frequently Asked Questions
Do I need a credit check to borrow on DeFi platforms?
No. Borrowing is permissionless; the only requirement is sufficient collateral.
What happens if my collateral is liquidated?
The protocol automatically sells the collateral on the open market. You lose the collateral and pay a liquidation penalty, but the loan is settled.
Can I borrow stablecoins without giving up my crypto?
Yes. Stablecoins like USDC or DAI are the most common loan assets because they don’t expose you to price volatility.
How are interest rates determined?
Platforms use algorithmic models that adjust rates based on supply‑demand ratios, utilization levels, and any governance‑set parameters.
Is it safe to use flash loans for arbitrage?
Flash loans themselves are safe because they revert if not repaid. The risk lies in execution errors, gas spikes, or price slippage.
Next steps and troubleshooting
If you’ve followed the Aave example and your health factor dropped unexpectedly, first check the price oracle feed. A sudden dip often means the oracle reported a lower price. Add more ETH or repay part of the loan to raise the health factor above 1.5.
For newcomers, start with a small loan (e.g., borrow $100 USDC against 0.1 ETH) to get comfortable with the UI and gas costs. Once you’re confident, you can experiment with variable rates or even flash‑loan strategies.
Remember, DeFi borrowing is powerful but comes with responsibility. Treat each loan like a live experiment-monitor, adjust, and never risk more than you can afford to lose.
pk Pk
October 18, 2025 AT 14:14If you’re looking to keep your crypto while getting cash, the first thing to lock in is a healthy over‑collateralization buffer. Aim for at least 20% above the platform’s minimum LTV so price swings don’t yank you into liquidation. Choose a platform with audited contracts – Aave, Compound, and MakerDAO are the usual suspects. Keep an eye on the health factor; staying above 1.5 gives you a comfortable safety margin. Set up price‑feed alerts, preferably with a reliable oracle like Chainlink. Have a small stash of ETH ready for gas fees when you need to top up collateral. Remember, the more diverse your collateral basket, the less likely a single asset dip will wipe you out.
NIKHIL TRIPATHI
October 19, 2025 AT 18:00When you start a loan on Aave, think of the LTV as a dial you can turn up or down. If you feel the market getting jittery, dial it back and add a bit more ETH – it’s a simple way to keep the health factor solid. Also, don’t forget to compare the stable‑rate vs. variable‑rate options; stable can save you from sudden spikes. A quick tip: borrow the smallest amount you actually need, that keeps your exposure low. Mix in a few different collateral types if the platform supports it; diversification works both in wallets and in loans. And always, always double‑check the gas costs before you hit confirm – those can bite you when the network is busy.
Shivani Vaidya
October 20, 2025 AT 21:47It is imperative, when engaging with decentralized lending protocols, to observe the stipulated collateralization ratios with utmost diligence. The contractual obligations inherent in a CDP demand that the borrower maintains a health factor exceeding the prescribed threshold. Failure to do so precipitates liquidation, wherein the collateral is sold to satisfy the outstanding debt. One should therefore monitor oracle feeds and establish contingency measures, such as supplemental deposits, to avert undesirable outcomes. Moreover, the selection of a platform possessing a robust audit history mitigates exposure to smart‑contract vulnerabilities. In summary, prudent management of over‑collateralization constitutes the cornerstone of sustainable DeFi borrowing.