DeFi Lending and Borrowing: How It Works, Top Protocols, and How to Get Started

The total value locked in DeFi lending markets has grown into a sustained, multi-billion dollar industry. As of early 2026, on-chain lending TVL sits at $60-$70 billion, with Aave holding a plurality of market share across its V3 and newly launched V4 deployments. This is no longer a speculative cycle story — it is a maturing financial infrastructure attracting institutional capital, real-world asset collateral, and cross-chain liquidity.

In this article, we are going to take a closer look at how DeFi lending and borrowing works, what benefits and dangers it bears, and what Liquid Loans does in order to alleviate these risks 

What is DeFi Lending and Borrowing?

Decentralized finance (DeFi) combines a whole ecosystem of blockchain-based financial applications under its hood. 

With the help of smart contracts and other innovative tools and features, it enables users to connect with each other on a peer-to-peer basis and manage their own assets in a self-custodial manner without having to rely on any third party.

DeFi lending and borrowing, in turn, is a set of services offering crypto loans in a trust-less form. 

With the help of appropriate protocols and platforms, borrowers can take loans with a few clicks of a mouse as they don’t have to submit any documents or even provide an ideal credit score. 

At the same time, cryptocurrency holders can safely lend their assets and earn passive income on their investments. 

CeFi vs DeFi Lending and Borrowing

In contrast to DeFi, Centralized Finance (CeFi) always implies a custodian to hold and manage users’ assets. Centralized exchanges and lending platforms route all transactions through servers they control, making users dependent on the platform’s solvency and honesty.

In many aspects, CeFi services act very similarly to traditional banks and other centralized financial institutions. They trade their reputation in exchange for user trust and assets, while managing security on users’ behalf.

The collapses of FTX and other centralized crypto lenders in 2022 demonstrated the counterparty risk this model carries. By contrast, DeFi lending protocols execute loans via audited smart contracts on public blockchains, removing the need to trust any single institution.

In 2026, the gap between CeFi and DeFi lending is widening further. DeFi protocols now support institutional-grade features including fixed-rate products, RWA collateral, and modular architectures, areas where CeFi platforms have historically held an advantage.

👉 Quick takeaway: CeFi lending is more familiar but puts your assets in someone else’s hands. DeFi lending is permissionless and transparent but replaces platform risk with smart contract risk.

Top DeFi Lending Protocols Compared

Not all DeFi lending protocols are built the same. Here is how the leading platforms compare across the metrics that matter most:

👉 Quick takeaway: Aave dominates on asset variety and cross-chain reach. Compound V3 offers the simplest risk model for conservative borrowers. Liquid Loans is the only protocol offering structurally interest-free loans against PLS collateral.

LTV = Loan-to-Value ratio. Higher LTV means you can borrow more per dollar of collateral deposited, but increases liquidation risk.

How to Choose: A Quick Decision Framework

• If you hold ETH or liquid staking tokens (stETH/wstETH) and want institutional-grade infrastructure: consider Aave V4
• If you want the simplest risk model with USDC borrowing: consider Compound V3
• If you are in the Base or PulseChain ecosystem and want interest-free borrowing: Liquid Loans is purpose-built for you
• If you hold real-world assets or want tokenized credit exposure: look for RWA-enabled markets on Aave V4 or specialized RWA protocols

Benefits of DeFi Lending and Borrowing

CeFi services failing their customers is not a novelty in the crypto world. FTX crash and other centralized crypto services failures that took place in 2022 are still fresh in the memory of cryptocurrency users. Thus, storing your funds on centralized platforms as well as using their lending services becomes questionable.

DeFi lending and borrowing services, on the contrary, are capable of solving many of the issues inherent to centralized solutions. Here are some of the key benefits that this approach provides:

• Transparency. Not all of the DeFi applications feature open-source code. Yet, unlike CeFi solutions, most of the transactions executed on such platforms are registered on a public blockchain. This makes them fully transparent and verifiable.
• Self custody. In contrast to CeFi, many DeFi lending and borrowing services enable users to store and use their funds on self-custodial wallets. Thus, users can be sure that no one will ever be able to block their wallets as they control their private keys.
• Accessibility. One can hardly find a CEX or a stock exchange that serves all the customers worldwide regardless of geography. Decentralized solutions, on the contrary, impose no limitations as they are accessible to all users worldwide.
• Flexible rates. DeFi lending and borrowing services offer algorithmically determined rates that often outperform traditional finance. In 2026, stablecoin lenders on major protocols have earned supply APYs ranging from 3-8% depending on market conditions, compared to the 0.5-1% typical of traditional savings accounts. Borrowers using highly liquid collateral like ETH can access loans at LTV ratios up to 80%, often at variable rates that compete with or undercut traditional secured lending.

Understanding LTV Ratios: How Much Can You Borrow?

Loan-to-Value (LTV) ratio determines how much you can borrow relative to the value of your collateral. In DeFi lending, LTV varies significantly by collateral type:

• Stablecoins as collateral: LTV up to 80-90% in some protocol configurations — lowest risk of liquidation due to price stability
• ETH and BTC as collateral: LTV typically 50-70% — reflects higher price volatility and liquidation risk
• Liquid staking tokens (e.g., stETH, wstETH): LTV similar to ETH, with additional consideration for slashing and de-peg risk
• Real-world assets (RWAs): LTV models still emerging, typically more conservative — 40-60% range depending on asset type and oracle quality

Example: If you deposit $10,000 worth of ETH at a 70% LTV, you can borrow up to $7,000 in stablecoins. If ETH price falls and your position drops to the liquidation threshold, your collateral may be sold automatically to repay the loan.

Risks of DeFi Lending and Borrowing

The advantages of the new approach are indisputable. Yet, there are also some negative aspects that one should consider as well.

• Liquidations. If the value of the collateral that borrowers provide falls below a predefined limit, the position may be automatically liquidated while borrowers will bear losses.
• Impermanent loss. Lenders may also face significant losses due to the high volatility of the crypto market unless they contribute stable assets to liquidity pools.
• Execution order malleability. With public permissionless blockchains, users openly share the information about transactions they intend to perform. Evil actors may use this information for their own benefit. They may influence transaction execution order by raising transaction fees and using other ways to manipulate the market.
• Flash loan attacks. What’s more, DeFi lending and borrowing services serve as an ideal tool for flash loan attacks. Hackers may exploit vulnerabilities in smart contracts and use the funds they get via flash loans to manipulate market prices.
• Regulatory and compliance risk. The regulatory landscape for DeFi lending is evolving rapidly in 2026. While decentralized protocols operate permissionlessly, institutional adoption is driving governance-level compliance discussions, particularly around KYC/AML for RWA-backed lending markets. Users in certain jurisdictions should verify local regulatory status before participating. The SEC’s engagement with DeFi protocols has also increased scrutiny on token classification and protocol governance structures.

The State of DeFi Lending in 2026: What Has Changed

DeFi lending has evolved significantly from its early days of simple crypto-collateralized loans. Three major shifts are defining the market in 2026:

1. Modular and hub-and-spoke architectures

Aave V4, which launched on Ethereum mainnet on March 30, 2026, introduced a hub-and-spoke lending model designed to reduce liquidity fragmentation across markets. Rather than siloed isolated pools, V4 connects liquidity across markets through a central hub, enabling deeper on-chain credit markets and reducing inefficiency. Aave also launched a dedicated Pro interface targeting institutional and advanced users.

2. Real-world assets (RWAs) as collateral

Tokenized real-world assets — including treasury bills, private credit, and real estate tokens — are increasingly accepted as collateral in DeFi lending markets. This expands the addressable collateral base beyond crypto and brings new institutional capital on-chain. RWA integration also introduces new risk considerations around oracle reliability and asset liquidity.

3. Liquid staking tokens (LSTs) as collateral

Tokens like stETH and wstETH (representing staked ETH) are now widely used as collateral across major protocols. This allows users to earn staking yield while simultaneously borrowing against their position, improving capital efficiency. However, de-peg events and slashing risk require careful LTV management.

How to Get Started With DeFi Lending and Borrowing

Whether you want to earn yield by lending or access liquidity by borrowing, here is how to get started:

Step 1: Choose your role

• Lender: You supply assets to a protocol’s liquidity pool and earn variable interest (supply APY)
• Borrower: You deposit collateral and borrow against it, paying variable or fixed interest

Step 2: Select a protocol

Use the comparison table above to match your collateral type and goals to the right protocol. For PulseChain users, Liquid Loans offers interest-free borrowing against PLS collateral. For Base users, Liquid Loans offers interest-free borrowing against their ETH collateral.

Step 3: Set up a self-custody wallet

You will need a Web3-compatible wallet (such as MetaMask or a PulseChain-compatible wallet) funded with the asset you intend to supply or use as collateral.

Step 4: Deposit collateral or supply assets

• To borrow: Navigate to the protocol, deposit your collateral, and set your borrow amount below the maximum LTV threshold to maintain a safe buffer against liquidation
• To lend: Supply your chosen asset to the liquidity pool and receive an interest-bearing token representing your position

Step 5: Monitor your health factor

Most protocols display a ‘health factor’ or collateral ratio. Keep this well above the liquidation threshold — especially during volatile market conditions. A health factor below 1.0 on Aave triggers automatic liquidation.

Step 6: Manage and exit

You can repay your loan at any time to retrieve your collateral, or withdraw your supplied assets when liquidity is available in the pool.

How Liquid Loans Lending Works: Interest-Free Borrowing on Base and PulseChain

Liquid Loans is built specifically for the Base and PulseChain ecosystem, offering interest-free loans backed by ETH and PLS collateral. Unlike variable-rate protocols like Aave or Compound, Liquid Loans charges a one-time borrowing fee rather than ongoing interest, making it uniquely capital-efficient for long-term borrowers.

Here is how the core mechanics work:

• Stability Pool and Liquidations. The Stability Pool is a smart contract holding $USDL (the Liquid Loans stablecoin). When a vault falls below the minimum collateral ratio and gets liquidated, the Stability Pool absorbs the debt and distributes the liquidated collateral to pool depositors. This mechanism protects the system’s solvency without requiring external liquidators.
• Minimum Collateral and LTV. To borrow $USDL, users deposit $ETH or $PLS into a vault. The protocol allows borrowing up to a 110% collateral ratio — meaning for every $110 of ETH and PLS deposited, up to $100 of USDL can be borrowed. This is a more capital-efficient model than many competing protocols that require 150% or more collateral for volatile assets.
• Redemption Mechanism. The redemption function allows any user to exchange $USDL for $ETH or $PLS at face value at any time. This provides a hard price floor for the stablecoin and ensures the peg is maintained algorithmically rather than through centralized reserves.
• Immutability and Trustlessness. Liquid Loans is deployed on a fully immutable, permissionless blockchain. No admin keys, no upgradeable contracts — the protocol operates exactly as deployed, removing governance attack vectors present in upgradeable protocols.