Lending and Borrowing 101

A lending and borrowing protocol is akin to a digital bank. It allows users to deposit cryptocurrencies like Ethereum (ETH) as collateral to borrow other tokens, such as stablecoins like USDT or any trusted token which is employed by the protocol.

These are known as overcollateralized loans, where the value of the collateral is higher than the loan itself. The key metric in these protocols is the Loan-to-Value (LTV) ratio. It's a financial term that measures the ratio of the loan to the value of the collateral. For instance, if you deposit $10,000 worth of ETH and borrow $5,000 in USDT, your LTV is 50%.

But there's a catch: if your LTV ratio exceeds a certain threshold (say, 80%), you risk liquidation, where your collateral is sold off to pay the loan.

Popular Protocols:

AAVE and Compound are two of the most renowned and 'battle-tested' protocols in the DeFi space. They have gained popularity for their robust security, user-friendly interfaces, and innovative features.

The Deposit and Borrow Flow:

Let's break down the process:

1. Deposit 10 ETH Assume 1 ETH = $2,200. So, depositing 10 ETH means your collateral value is $22,000.

2. Borrow 15,000 USDT To calculate the LTV ratio:

Borrowed Value / Value of collateral * 100

-> 68.18%

After borrowing, it's crucial to monitor the ETH price. Remember, if the LTV ratio falls below 80%, you risk liquidation. To find the ETH price at which your LTV hits 80%, we'll use the formula:

Liquidation Price = Borrowed Value/(0.8 * ETH amount)

-> $1,875

That's the danger zone where you risk liquidation. In an effort to not get liquidated, either you must repay your loan or increase your underlying value.

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