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What is a lending protocol?
A lending protocol is a set of smart contracts where people deposit crypto to earn interest and others borrow from that pool by locking up collateral worth more than the loan. Rates and repayment are enforced by the code rather than a lender.
What it means for you
If your collateral falls in value, the protocol can sell part of it automatically to repay your loan, with a penalty. Deposits depend on the contracts and the price feeds they read; a fault in either can cost lenders money. Check the liquidation threshold and your position's health before borrowing.
How it works
Lenders deposit tokens into a shared pool and receive interest-bearing receipt tokens. Borrowers must first supply collateral worth more than the loan. Interest rates are not negotiated: they move with utilization, the share of the pool currently borrowed, so rates rise when funds run short. Each collateral asset has a loan-to-value limit on borrowing and a separate liquidation threshold. A health factor compares collateral, weighted by that threshold, with the debt; once it falls below 1.0, any account can repay part of the debt and take collateral at a bonus.
An example
Say you deposit collateral worth 1,000 with a 75% loan-to-value limit and an 80% liquidation threshold. You can borrow up to 750. Borrow 600 and your health factor is 1,000 × 0.8 ÷ 600, about 1.33. If the collateral falls to 750, it reaches 1.0 and liquidation can begin.
Sources: Aave documentation, ECB Macroprudential Bulletin: Decentralised finance, Aave documentation: Liquidations · checked 4 October 2026
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Educational content, not financial advice. Written by hand and checked against the source named above. Something wrong? Tell us and we reply within two business days.