Anyone can borrow crypto by depositing collateral into DeFi lending protocols. Speculation is the main use case for borrowing in DeFi. Borrowers must make sure their loans stay well collateralized or risk liquidation.
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The basics of borrowing in DeFi
DeFi allows people to borrow cryptoassets from a pool of lenders. The lenders receive yield from the interest borrowers pay. If you are new to the idea of lending or borrowing, please read the following article: What is crypto lending?
To borrow, you’ll first need to deposit funds into the protocol. These funds will act as collateral for your loan. If you haven’t deposited any cryptoassets yet, check out this support article on how to lend in DeFi.
If the value of the collateral falls below a certain amount, your collateral will be liquidated automatically by the protocol. Before borrowing anything, please read the Loan-To-Value and Health factor sections below.
Borrowing use cases
The current primary use case for borrowing in DeFi is to increase exposure to cryptoassets. Here are some examples of how people often use their loans:
Increase exposure to markets: This allows you to hold a cryptoasset you have strong convictions about and use it as collateral to further participate in markets. For example, deposit $1000 in ETH → borrow $500 in DAI → buy $500 in ABC token using DAI.
Leveraged long: This allows you to hold more of a cryptoasset than you could otherwise. For example, deposit $1000 in ETH → borrow $500 in DAI → buy $500 in ETH using DAI. With this strategy, you’ll have 50% more ETH than you could have. Another way to put it is that you will have leveraged your ETH position by 50%.
Earn time sensitive yield: Many DeFi protocols offer transient attractive yields on borrowing platforms like Aave to attract liquidity and mind share. More advanced users take advantage of yields offered on both the borrow and lend side during these limited windows. For example, new token ABC is offering 15% APY on Aave for ABC deposits and 7% APY for borrows. Deposit $1000 in ETH → borrow $500 in ABC (Paying 2% on the loan means you will earn 5% overall) → deposit $500 ABC (earn 15%).
Introduction to Aave
You can read more about WalletConnect here.
Here’s a guide for how to use WalletConnect.
The importance of Loan-To-Value
The ratio between a loan and collateral is called Loan-To-Value, or LTV for short. The LTV ratio defines the maximum amount of assets that can be borrowed with a specific collateral. For example, imagine you deposit ETH for collateral. The LTV can change over time, but let’s imagine it has an LTV=75%. This means that for every 1 ETH worth of collateral, you will be able to borrow 0.75 ETH worth of the corresponding asset, such as DAI or USDC.
High volatility cryptoassets like Wrapped Bitcoin, Ethereum, and particularly other lesser known coins can see rapid decreases in value. If you use these assets as collateral and the value of those assets rapidly depreciates, you can be liquidated before you can add more collateral. Stablecoins are much less volatile, and are the preferred collateral for that reason.
In Aave, it’s important to watch the Health factor of your loans.
Watch the Health factor
The Health factor is a calculation that gives an overview of the risk of liquidation of a loan position. When the Health factor is less than 1, part or all of the collateral may be liquidated to maintain solvency.
When choosing an amount to borrow, or on your current positions, you also see the real-time LTV For example, in the below images you can see three potential LTVs from risky (red) to safer (green) for three borrow amounts. The collateral is 39.19 USDC.
Notice with this low Health factor position you must click a waver acknowledging the risks.
Step-by-step guide to borrowing on Aave
Here’s how it works:
Go to https://app.aave.com/
Choose WalletConnect as the connection method, and select Bitcoin.com Wallet.
In the Bitcoin.com Wallet, approve the connection request.
Go back to Aave and tap the “Borrow” tab. On Aave, you can choose amongst an available list of assets to borrow. Notice that each available asset has a different interest rate (APY) you pay for borrowing.
When you’ve decided on an asset to borrow, click the “Borrow” button. Decide how much to borrow by typing a number, or clicking the “MAX” button to borrow as much as you can based on your available collateral. Keep in mind the composition of your collateral, and pay special attention to the potential Health factor.
Aave will calculate an estimate for your gas cost. When this calculation is finished and you are willing to pay it, tap the “Borrow XXX” button (where XXX is the cryptoasset you are borrowing).
You will be taken to the Bitcoin.com Wallet, or select the Bitcoin.com Wallet. In the Bitcoin.com Wallet, approve the transaction. Note, the final gas fee (Network fee) might not match the estimate provided by Aave.
Return to Aave and wait for the transaction to finalize. This can normally take up to 10 minutes depending on the congestion of the network.
When the transaction finalizes, an “All done!” popup will appear. Congratulations, you have take out a collateralized loan!