How do Interest Rates work In DeFi?

May 20, 2021 1 min read

An important difference between DeFi and CeFi (centralised finance) in lending and borrowing is that the interest rates are usually calculated for each block on the chain, according to the supply and demand for each particular asset. For example: if the money market for ETH is smaller than the one for DAI, and there is equal demand for both, then the lending interest rate for ETH will be higher than the one for DAI, incentivising users to lend their ETH to the protocol.

While this is an improvement with respect to the usually slow-changing interest rates of CeFi, which can’t respond to the market demands as quickly, it also means that it’s necessary to constantly keep up with the rates if you want the best performance. It also applies to the borrowing interest, so you need to keep track of the changes so that you know how much interest you will need to pay back. If you want to take a more hands-off approach to borrowing, Aave also offers a stable borrowing instrument, which doesn’t change in the short term.

As far as the practicalities are concerned, using lending and borrowing Dapps is similar to using DEXes. All you need is a wallet and you’re good to go: just go to the dApp website, connect your wallet and choose the token that you want to supply or borrow.

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