Crypto 101 · DeFi
Crypto Lending and Borrowing: How On-Chain Interest Works
Abstract
In on-chain lending markets, lenders deposit assets to earn interest and borrowers post collateral to take loans; algorithms set the interest rate from supply and demand. We explain the mechanics in plain language, show where the yield comes from, and cover collateral ratios, liquidation and smart-contract risk.
Keywords: DeFi lending, borrowing, collateral, liquidation, interest rate, yield
1. In plain English
A lending market works like a pawn shop run by software. Lenders deposit tokens into a shared pool and earn interest. Borrowers take tokens out but must first lock up more value in collateral than they borrow. There is no credit check: the safety comes from that over-collateralisation and from automatic rules.
Interest rates are not negotiated. They are set by an algorithm from supply and demand. When lots of the pool is borrowed, rates rise to attract lenders and discourage borrowing; when little is borrowed, rates fall [1].
2. Where the yield comes from
A lender's return is paid by borrowers. That makes it a useful test for any advertised yield: identify who is paying and why. The full method is in yield provenance.
3. Go deeper: collateral and liquidation
Suppose you deposit 150 of a token and borrow 100 of a stablecoin. If the collateral's price falls until its value is close to the loan's, the protocol lets others repay part of your debt in exchange for a discounted share of your collateral. That is liquidation. It protects lenders but means a borrower can lose collateral quickly in a sharp price drop [1]. Borrowers usually keep a safety margin well above the minimum.
4. Risks
- Liquidation risk if collateral falls quickly.
- Smart-contract risk: bugs can lose funds even with sound economics.
- Rate risk: variable rates can change.
- Oracle risk: markets rely on price feeds; wrong prices can trigger wrong liquidations.
5. A numeric example
Suppose a pool holds 1,000 units of a stablecoin and 700 are borrowed. Utilisation is 700 / 1,000 = 70%. If borrowers pay 6% and the protocol passes most of it to lenders, a lender earns roughly 6% x 70% = 4.2% before any protocol share, because only the borrowed part earns interest. When utilisation rises, rates rise; when it falls, rates fall. This is the supply-and-demand logic behind on-chain rates [1].
6. In Scrypt Wallet
Scrypt Wallet's Earn section lists lending and staking options in one place. Read the details and the risks for each before depositing, and see the swaps guide for how tokens are exchanged.
References
- Leshner, R., & Hayes, G. (2019). Compound: The Money Market Protocol. Whitepaper describing on-chain lending markets in which interest rates are set algorithmically by supply and demand. https://compound.finance/documents/Compound.Whitepaper.pdf
Common questions
Where does lending interest come from?
From borrowers, who pay it to use the capital. If nobody borrows, lenders earn little.
What is liquidation?
If a borrower's collateral falls too far in value, the protocol sells part of it to repay the loan.
General education, not financial, tax or legal advice. Figures are schematic. Protocol parameters are cited to primary sources and can change; verify against the linked source before relying on them.