Technological advancements have brought about a new way of handling finances: DeFi (Decentralized Finance) protocols based on blockchain technology. One of the key aspects of this financial revolution is the ability to obtain loans directly on the blockchain, in a fast, secure, and transparent manner. Among the various available DeFi protocols, AAVE stands out as an accessible and user-friendly alternative.
In this article, we will explore how loans work on the blockchain and demonstrate how the AAVE protocol makes this task simple and efficient. If you are curious about using your crypto assets to obtain loans or want to learn more about DeFi possibilities, continue reading to discover how to take the first steps in this innovative universe.
We will unravel the loan process on the blockchain by drawing an analogy with a conventional pawn shop and highlight the advantages of using AAVE as a loan platform. Additionally, we will address the risks involved in this type of lending and how to mitigate them.
If you have heard about Decentralized Finance but haven’t yet explored all its opportunities, this article is for you. Get ready to dive into the world of decentralized loans and discover how the AAVE protocol can revolutionize your financial transactions.
Many people have doubts when it comes to obtaining loans directly on the blockchain using DeFi protocols, but nowadays, it has become a relatively simple task. Nowadays, there are numerous DeFi protocols with user-friendly interfaces that undoubtedly compete with major centralized financial products, and one of them is AAVE.
HOW DOES LENDING WORK ON AAVE?
The operation is simple; it’s similar to a pawn shop. You go there and leave a watch valued at $2,000 as collateral. The pawn shop then lends you $1,500. When you return, you pay back the borrowed amount plus interest and retrieve your watch.
In the case of cryptocurrencies, it’s similar. You leave the accepted assets as collateral with the protocol, usually WBTC, ETH, and some others. The operation will always be overcollateralized. For example, if you leave the equivalent of $2,000 as collateral, you will have approximately $1,600 available for borrowing, which can be in stablecoins or other assets, depending on your strategy.
You earn a yield by providing your $2,000 and pay interest to borrow the $1,600.
WHAT ARE THE RISKS?
The assets you provide are subject to volatility. For instance, if you provided $2,000 worth of ETH and, due to volatility, the value of that collateral drops to $1,700, your operation would be liquidated. There is a liquidation penalty when the collateral reaches a minimum threshold. Therefore, it’s important to monitor the operation to maintain a healthy margin. Before being liquidated, you can add more ETH as collateral to keep the operation running. In this case, the risk would be getting liquidated and paying a fee.
IN WHICH SITUATIONS IS IT INTERESTING TO TAKE OUT A LOAN?
Using the same example of ETH, let’s say you need $1,000 for an emergency but have $2,000 worth of ETH and are optimistic about the market. You don’t want to sell your ETH at the moment. So, you provide your $2,000 worth of ETH and borrow $1,000 in stablecoin. If ETH appreciates and the provided ETH, initially valued at $2,000, doubles in value to $4,000, you can simply return the borrowed $1,000 plus interest and retrieve your ETH, now worth $4,000.
HOW TO TAKE OUT A LOAN USING THE AAVE PROTOCOL?
Now that you understand the mechanics of lending in DeFi protocols let’s follow a step-by-step guide to taking out a loan.
- Go to the AAVE website.
- Connect your wallet in the upper right corner, as shown in the image bellow:
3. On the screen below, on the left side, you will see the assets you can provide as collateral, and on the right side, the assets you can borrow.
4. Choose the asset you want to provide as collateral and click on “Supply.” Then, select the quantity you wish to provide and approve the transaction, as shown on the screen below.
4. Choose the asset on the right side that you want to borrow, click on “Borrow,” select the quantity you wish to borrow, and approve the transaction.
Congratulations! You have now provided collateral and made your first loan directly on the blockchain.
By unraveling the functioning of loans on the blockchain and using the AAVE protocol as an example, we hope to have provided you with a clear and accessible view of DeFi possibilities. Now you are prepared to explore this fascinating world on your own.
With the emergence of increasingly user-friendly and sophisticated DeFi protocols, it is evident that decentralized finance is gaining ground and competing on equal terms with centralized financial products. AAVE is just one of the many options available, and each of them offers unique opportunities to maximize your financial potential.
Remember to manage the risks involved because while blockchain loans can bring significant benefits, it is crucial to monitor asset volatility and maintain a healthy margin to avoid unwanted liquidations.
As you progress on this journey, developing strategies and exploring new opportunities, always keep an eye on the changes and innovations shaping the crypto market.
Now that you have the tools, knowledge, and confidence to embark on this journey of blockchain loans, we wish you success in your transactions and encourage you to make the most of DeFi advantages. Be part of the financial revolution and discover a new world of financial freedom and autonomy.