TL,DR: Today we’ll explore the fundamental principles of lending, how collateralized lending became a cornerstone of trust, how lending protocols in DeFi encode these principles in code (with examples like Aave, Compound, and MakerDAO), and how stablecoins keep these protocols stable.
We’ll also peek into the future at emerging ideas like undercollateralized loans, credit delegation, and intent-based lending that hope to make lending more inclusive and efficient. Through it all, we remember: these innovations matter because of the people they empower—lenders, borrowers, dreamers, and doers across the world.
A farmer stands in a sunbaked field, worried. His crops failed, and he needs seed to plant again. In a nearby village, a storekeeper has grain. A simple conversation occurs: if you lend me grain today, I promise to repay you after the harvest, with a bit extra as thanks.
With this exchange, the essence of lending is born. Lending has always been a human-centered dance: one person helping another with resources, expecting repayment with reward.
The lender puts idle assets to work and earns interest; the borrower gains immediate access to funds or goods to solve a problem. This runs on trust, the belief that the borrower will repay in the future. Interestingly, history shows that whenever trust wavers, systems evolve to protect both sides. We write rules, pledge collateral and sign contracts.
In our modern era, especially in the realm of decentralized finance (DeFi), we are rediscovering these first principles and reimagining them with new technology.
Strip away modern complexity, and lending boils down to a simple principle:
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I give you 1 now, and you give me 1+x later.
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x is interest, the reward for the lender’s patience and risk.
Think of the first time you lent to a person. Perhaps it was a pencil or a toy. Early lending is usually among people who knew each other well, but as societies grow, it extends. Merchants might lend to distant traders, or wealthy individuals might finance community projects. And with expansion comes formal agreements and safeguards.
People developed legal systems to enforce contracts and impose penalties for defaults. Interest rates appeared not just as profit, but a pricing of risk and time. In fact, many ancient texts grapple with interest and fairness in lending. The Babylonian Code of Hammurabi (1750 BC) set out one of the first lending regulations. It capped interest rates and described how collateral could be used to secure loans. By limiting interest and allowing assets to guarantee a loan, Hammurabi’s laws aligned lending practices with the first principles of fairness and trustworthiness.
A borrower provides something of value as a backup, so if they cannot repay the loan, the lender can recover funds by taking that asset. When you take a mortgage to buy a house, the house becomes collateral.
From the borrower’s perspective, it can be tasking. You must have valuable assets to get a loan, and you often have to over-collateralize, providing collateral worth more than the loan itself. If you pawn a $1000 watch for a $700 loan, the pawn broker has a cushion in case the watch’s resale value drops. Similarly, in a crypto lending scenario, you might need to post $150 worth of Bitcoin to borrow $100 worth of stablecoins. The 150% ratio ensures that even if the crypto price dips, the loan is still covered.
The borrower gains access to liquidity but at the cost of locking up assets. The lender sleeps easier, but the lending is limited to the value of collateral the borrower can produce. It’s safe but capital-inefficient. Lots of value sits tied up. In DeFi, this was the starting point—majority of loans are over-collateralized, as blockchains initially had no better way to establish trust.
But as we’ll see, builders are exploring how to relax this requirement safely.