DeFi Basics: How to Lend & Borrow Crypto in 2026
Learn how to lend and borrow crypto on DeFi platforms like Aave and Compound. Understand collateral, interest rates, and liquidation risks in this
DeFi Basics: How to Lend & Borrow Crypto in 2026
Put your crypto to work or access liquidity without selling your holdings
Decentralized lending and borrowing is one of the core pillars of DeFi, allowing anyone to earn interest on idle crypto assets or borrow funds without going through a bank. Protocols like Aave and Compound have facilitated billions of dollars in loans using smart contracts instead of intermediaries.
This guide explains how DeFi lending works, walks you through supplying and borrowing assets on major platforms, and covers the critical concepts of collateralization and liquidation. Understanding these mechanics is essential before you put any funds into a lending protocol.
What You'll Need
- A Web3 wallet like MetaMask connected to Ethereum, Arbitrum, or another supported network
- Crypto assets to supply as collateral or to lend for interest
- Enough native tokens (ETH, MATIC, etc.) to cover gas fees for transactions
- Basic understanding of how smart contracts work
Step-by-Step Guide
Step 1
Understand How DeFi Lending Works
DeFi lending protocols operate through liquidity pools. Lenders deposit their crypto into a smart contract pool and earn interest from borrowers who take loans from that pool. Interest rates are determined algorithmically based on supply and demand for each asset.
Borrowers must deposit collateral worth more than their loan, a concept called over-collateralization. If the value of your collateral drops below a certain threshold relative to your loan, your position gets liquidated, meaning the protocol sells your collateral to repay the debt.
Step 2
Choose Your Lending Platform
Aave is the largest DeFi lending protocol, available on Ethereum, Arbitrum, Optimism, Polygon, and several other chains. It offers a wide variety of assets and features like flash loans and rate switching between variable and stable rates.
Compound is another well-established protocol known for its simplicity and strong security track record. Both platforms have user-friendly interfaces and have been audited extensively. Compare interest rates and supported assets on each to decide which suits your needs.
Step 3
Supply Assets to Earn Interest
Navigate to the Aave app at app.aave.com or Compound at app.compound.finance and connect your wallet. Select the asset you want to supply from the available markets and click Supply. Enter the amount, approve the token if this is your first time supplying it, and confirm the transaction.
Once supplied, you will begin earning interest immediately. On Aave, you receive aTokens that represent your deposit and accrue interest in real time. Your supplied assets also serve as potential collateral if you decide to borrow later.
Step 4
Borrow Against Your Collateral
After supplying collateral, you can borrow other assets against it. Navigate to the Borrow section, select the asset you want to borrow, and enter the amount. The interface will show you your health factor, which indicates how safe your position is from liquidation.
Keep your health factor well above 1.0, ideally above 1.5 or higher. A health factor of 1.0 means your position can be liquidated. Borrowing conservatively, meaning taking a loan significantly smaller than your maximum allowed amount, gives you a buffer against price volatility.
Step 5
Monitor Your Position and Health Factor
After borrowing, regularly check your position dashboard on the lending platform. Your health factor changes as the prices of your collateral and borrowed assets fluctuate. If markets move against you, you may need to add more collateral or repay part of the loan.
Set up alerts using tools like DeFi Saver or Hal.xyz to notify you when your health factor drops below a threshold you set. Some users also configure automated liquidation protection that adds collateral or repays debt automatically when positions become risky.
Step 6
Repay Your Loan
When you are ready to close your borrowing position, go to the Borrow section and click Repay next to the asset you borrowed. You will need to repay the principal plus any accrued interest. Make sure you have enough of the borrowed asset in your wallet to cover the full amount.
After repayment, your collateral is freed up and your health factor returns to a safe level. You can then withdraw your supplied assets if you no longer wish to earn lending interest. Always confirm the full repayment amount before executing the transaction.
Step 7
Withdraw Your Supplied Assets
If you have no outstanding borrows, you can withdraw your full supplied balance at any time. Go to the Supply section and click Withdraw next to the relevant asset. If you have an active loan, you can only withdraw collateral that is not needed to maintain your health factor.
Keep in mind that withdrawal may fail if the utilization rate of the pool is very high, meaning most of the deposited assets are currently being borrowed. In rare cases of extreme utilization, you may need to wait for borrowers to repay before you can fully withdraw.
Tips & Best Practices
- Start by lending stablecoins like USDC or DAI to earn interest with minimal price volatility risk before exploring more complex strategies.
- Use DeFi Llama to compare lending rates across multiple protocols and chains to find the best yields for your assets.
- Never borrow the maximum amount allowed. Keep your loan-to-value ratio conservative to avoid liquidation during sudden market drops.
- Consider using Aave on Layer 2 networks like Arbitrum or Optimism to significantly reduce gas costs compared to Ethereum mainnet.
- Review the risk parameters for each asset on the protocol documentation, as different tokens have different collateral factors and liquidation thresholds.
Important: DeFi lending carries significant risks including smart contract vulnerabilities, oracle manipulation attacks, and liquidation during volatile markets. You can lose your entire collateral if prices move sharply against your position. Only lend and borrow amounts you can afford to lose and always maintain a healthy buffer above the liquidation threshold.
Frequently Asked Questions
What happens if I get liquidated?
When your health factor drops to 1.0, liquidators can repay a portion of your debt and seize your collateral at a discount, typically 5% to 10%. You keep the borrowed assets but lose the equivalent collateral plus the liquidation penalty. This is why conservative borrowing is essential.
What interest rates can I expect from DeFi lending?
Lending rates vary by asset and market conditions. Stablecoins typically yield between 2% and 8% APY, while volatile assets like ETH may yield 1% to 3%. Borrowing rates are higher than lending rates and fluctuate based on pool utilization.
Is DeFi lending better than staking?
They serve different purposes. Staking secures a blockchain network and earns protocol rewards, while lending earns interest from borrowers. Lending offers more flexibility in asset choice but carries smart contract and liquidation risks that staking does not. Many investors use both strategies.
CryptoTakeProfit Research Team
Our team of analysts and traders covers the crypto market daily. We combine on-chain data, technical analysis, and fundamental research to bring you actionable insights.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. Cryptocurrency investments carry significant risk. Always do your own research and never invest more than you can afford to lose. This article may contain affiliate links.
