FOLLOW THE MECHANISM
- 1Supply
- 2Borrow
- 3Accrue
Interest increases debt and supplier entitlement under pool rules.
- 4Repay or liquidate
Recovered assets replenish available liquidity.
A conceptual sequence. Real implementations can add steps, intermediaries, and conditions.
Credit connects two balance sheets
A lender gives up immediate use of assets in exchange for a claim to repayment or withdrawal under defined conditions. In pooled DeFi lending, smart contracts aggregate suppliers’ assets and let borrowers draw liquidity, usually against eligible collateral. Suppliers hold accounting claims while borrowers owe debt. This differs from staking, where assets support consensus duties. A platform may combine both, but the reason a return exists must still be traced to the particular activity.
Where supplier yield comes from
Borrowers pay interest for using liquidity. In a simplified pool, the supplier rate is approximately the borrow rate multiplied by utilization and by the share not retained as reserves. If only half the supplied funds are borrowed, not every supplied unit is earning the full borrower rate. Protocol incentives may add another payout funded separately. Actual formulas, reserve accounting and interest indices vary by version, asset and market, so this relationship is an explanatory model rather than an exact current quote.
Available cash differs from recorded claims
Suppose suppliers have claims totaling 1,000 units and borrowers owe 700 units. Ignoring interest and reserves, 300 units remain available in the pool. A 400-unit immediate withdrawal cannot be satisfied entirely from that cash even if the debts are fully recoverable. Repayment, new deposits or permitted liquidity mechanisms may be needed. This is a liquidity constraint. If borrowers cannot repay and collateral recovery is insufficient, the pool instead faces a loss of assets relative to claims: a solvency problem.
Collateral reduces risk without eliminating it
Collateral and liquidation are intended to protect lender repayment, but collateral prices can gap down, oracles can fail and liquidators can lack capacity. A contract or governance failure can also cause loss independently of borrower behavior. Centralized lending introduces an operator’s custody, underwriting and balance-sheet risks rather than automatically inheriting a DeFi pool’s rules. A lender’s claim therefore depends on asset quality, execution, control and exit mechanics, not merely the visible annual rate.
MAKE IT CONCRETE
Illustrative rate bridge
At 8% borrower APR, 50% utilization and a 10% retained share, the simple supplier-rate approximation is 8% × 0.5 × 0.9 = 3.6%, before incentives, losses and changing conditions.
FAILURE PATHS & COMMON MISREADINGS
Where the model can break
- A positive account balance may exceed immediately withdrawable cash.
- Overcollateralization does not make lender principal guaranteed.
KEEP EXPLORING