// GLOSSARY -- DEFI

What is Lending Protocol?

1 min read Updated

A lending protocol is a DeFi application that enables permissionless borrowing and lending of crypto assets through smart contracts — with interest rates determined algorithmically by supply and demand.

WHY IT MATTERS

DeFi lending removes the bank. Instead of a financial institution deciding who can borrow and at what rate, smart contracts manage everything: deposit pools, interest calculations, collateral requirements, and liquidations.

Major protocols: Aave (largest, multi-chain), Compound (pioneer), and Morpho (optimized rates). Lenders deposit assets and earn interest. Borrowers post collateral and pay interest. Rates adjust automatically based on pool utilization.

All DeFi lending is overcollateralized — you must deposit more value than you borrow. This eliminates credit risk but limits capital efficiency. Undercollateralized lending exists but requires trust assumptions.

FREQUENTLY ASKED QUESTIONS

How are interest rates set?
Algorithmically based on utilization (borrowed/total deposits). Low utilization: low rates to encourage borrowing. High utilization: high rates to attract deposits and discourage borrowing.
What happens if my collateral drops?
If your loan-to-value ratio exceeds the liquidation threshold, anyone can liquidate part of your collateral to repay the loan. This happens automatically through liquidation bots.
Why borrow if I need to overcollateralize?
Tax efficiency (borrow vs sell), leverage (borrow stablecoins to buy more crypto), and yield strategies (use borrowed assets in other protocols). Borrowing maintains exposure to the collateral asset.

FURTHER READING

Enforce policies on every tool call

Intercept is the open-source MCP proxy that enforces YAML policies on AI agent tool calls. No code changes needed.

npx -y @policylayer/intercept
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