Decentralized lending protocols allow users to borrow and lend cryptocurrency through smart contracts, without any underwriting institution, credit bureau, or loan officer involved in the process. The model replaces credit assessment entirely with collateralization — a user who wants to borrow must first deposit more than the borrowed amount in a different cryptocurrency, and the smart contract manages the rest.

The process begins with a liquidity provider depositing an asset — say, ether — into a lending protocol. That deposit is available for borrowers to withdraw, provided they first lock collateral into the same smart contract. Lending in defi generally requires over-collateralization: the collateral deposited must exceed the value of the loan, often significantly, to provide a buffer against the price volatility common in cryptocurrency markets. The smart contract tracks the loan-to-value ratio continuously, relying on oracles to feed it current price data for both the collateral and the borrowed asset.