DeFi Guide to How Solana Crypto Lending Works

This article is not financial advice. Kamino Finance does not endorse any tokens or platforms mentioned in this article.

Overview

• DeFi crypto lending is transparent and very different from CeFi.
• Solana DeFi loans are over-collateralized and can be liquidated.
• Lending rates are determined algorithmically by a smart contract.

Kamino Finance is dedicated to educating users about decentralized finance (DeFi) and how DeFi works. As the Solana DeFi community continues to expand, it’s important that the users who depend on the network’s decentralized applications (dApps) to participate in DeFi can do so with as much information at their disposal as possible.  

This is the first article in Kamino Finance’s series on crypto lending. The Solana DeFi ecosystem provides several opportunities to lend crypto, and this guide will begin by explaining the basics of Solana lending. This introduction is not comprehensive, and users should always DYOR before participating in DeFi.

What is a DeFi Crypto Lending Protocol?

In DeFi, crypto lending is facilitated by smart contracts that allow users to lend and borrow crypto from each other in a trustless manner. This means that decentralized lending on Solana is mediated by code rather than middlemen and other intermediaries, which is more common in CeFi.

The Aave lending protocol was one of the pioneers in DeFi lending, and it differentiated itself from CeFi services like Nexo crypto lending or Celsius crypto lending by offering a peer-to-peer money market with transactions and reserves that could be verified on the blockchain. For CeFi lending protocols like Celsius and Nexo, this isn’t the case.

DeFi lending separates itself from other forms of crypto lending because of its transparency, lack of maturity dates, and reliance on users to custody their own assets. When CeFi lenders run into trouble, they end up using their users' assets to cover their own debts, but the mediation of smart contracts ensures that this does not happen in DeFi.

How do Solana Lending Platforms Operate?

When users participate in DeFi lending and borrowing, they interact with smart contracts that follow a set of rules coded onto the blockchain. Lenders deposit assets into a smart contract, and borrowers who have also deposited assets into the smart contract can then borrow tokens from other users.

DeFi lending platforms require over-collateralization of loans in order for users to borrow tokens from their smart contracts to ensure loans can be repaid. If the value of a borrower’s deposit comes close to exceeding the value of their loan, they can be liquidated.

The few instances when an under-collateralized loan can be made in the Solana lending ecosystem is when users borrow for leveraged yield farming (LYF), with some examples being Francium and Tulip lending. For each of these protocols, risk is managed since the platform sets each LYF position using the funds loaned.

How are DeFi Lending Rates Determined?

Most of Solana’s lending protocols, like Solend, one of the original lending platforms on Solana, adjust the maximum loan-to-value ratio (LTV) depending on the quality of each asset. Usually, more volatile assets and less established assets lacking deep liquidity for easy liquidations are assigned a lower LTV.    

Lending rates are determined by user activity, and a DeFi lending protocol’s APR for each asset is guided by these rules based on how much of an asset is borrowed versus its supply, or its utilization rate. Then, Solana lenders earn these rates as rewards for depositing their tokens and helping facilitate transactions.

Why do Users Borrow from Solana Lending Platforms?

There are many reasons why users lend and borrow crypto on Solana lending platforms. Some users lend Solana tokens to put their capital to work and earn yield while holding, but many users deposit their crypto on lending platforms for leverage or the opportunity to short an asset.

For example, a Solend Solana leverage strategy involves depositing SOL and borrowing stablecoins to take a larger position in SOL. In reverse, a shorting strategy would deposit stablecoins on Solend to borrow assets with directional exposure to the market, hoping that they depreciate in value.

What are the Best Solana Lending Platforms?

Lending on Solana can take many forms, and users have multiple options to lend crypto on Solana to earn yield from different protocols offering different services. Kamino Finance’s next article on DeFi lending will explore the best DeFi lending protocols to lend crypto on Solana, and it will take a more in-depth look at the possibilities of several lending platforms.

The article will explore options like Francium and Tulip lending, which is utilized for leveraged yield farming. In addition, other kinds of lending protocols that specialize in real-world assets (RWA), like Credix, and perpetual futures, like Drift Protocol, will be introduced.

These introductions are by no means exhaustive surveys of the Solana lending ecosystem, nor are they comprehensive tutorials for DeFi lending. Lending on Solana is a constantly shifting landscape, and users should always do as much research as possible before participating in any DeFi lending activity.