Crypto Lending: Where the Yield Comes From
Every lending yield is someone else’s interest payment, or a subsidy that will end. Before you deposit, find out which one you are being paid.
Follow the money
When you lend crypto, your return comes from one of four places:
- Borrowers’ interest. The most durable source. In DeFi money markets borrowers pay a variable rate and lenders receive most of it.
- Token incentives. Protocols often pay their own token on top to attract deposits. These rewards depend on the token’s price and usually shrink over time.
- Strategy returns. Some products called “lending” actually trade or farm with your deposit. That is not lending, and the risks are different.
- A company’s balance sheet. Some centralized platforms paid fixed rates higher than they earned and covered the gap themselves, until they could not.
If you cannot tell which of these pays your yield, treat the product as high risk.
How a DeFi pool sets your rate
In pools such as Aave or Compound, deposits from many lenders sit together and borrowers draw from them. The number that matters is utilization: the share of the pool currently lent out. When utilization is low, borrowing is cheap and lenders earn little. As it rises, rates climb slowly at first, then steeply above a level set by the protocol, to attract new deposits and push borrowers to repay.
Two consequences follow. Your yield is never fixed and can double or halve in a day. And utilization decides whether you can leave: if almost everything is lent out, there may be nothing to withdraw until borrowers repay or get liquidated. High rates and stuck withdrawals tend to arrive together.
A step-by-step walkthrough of depositing into a pool is in how to lend crypto in a DeFi lending pool.
Ways lenders lose money
Smart contract failure. A bug can let an attacker drain a pool. Audits lower this risk but do not remove it; see what an audit covers.
Bad debt. If collateral crashes faster than liquidators can sell it, some loans end up worth more than their backing. Lenders absorb the shortfall unless the protocol has a reserve to cover it.
Oracle problems. Pools rely on price feeds. A wrong or manipulated price can let someone borrow against inflated collateral.
The asset itself. Lending a volatile token earns interest in that token. A small yield does not help much if the token loses a large part of its value. Lending stablecoins avoids this but adds depeg risk.
The platform. With centralized lending you also depend on the company staying solvent, as customers of several lenders that failed in 2022 learned.
Lending to companies instead of pools
A separate market lends to businesses and trading firms on the basis of credit assessment rather than crypto collateral. Returns can be higher and steadier, but when a borrower defaults the loss is real and recovery is slow. That market is covered in tokenized private credit and on-chain credit use cases.
Five checks before you deposit
- Which of the four sources pays the yield?
- How high is utilization, and could you withdraw your full deposit today?
- How long have the contracts been live, who audited them, and has the protocol had incidents?
- Is there a reserve or insurance fund for bad debt, and how large is it compared with the pool?
- Which network are you on? The same protocol on a smaller chain can have thinner liquidity, as our guide to crypto lending on Polygon shows.
Lenders often ask
No. Staking locks tokens to help secure a proof-of-stake network and is paid by that network. Lending hands tokens to borrowers and is paid by their interest.
The rate follows utilization, so every large deposit, withdrawal or new loan moves it.
Only if the pool has funds that are not lent out. At very high utilization you may have to wait until borrowers repay.
No. Variable DeFi yields change constantly, and a fixed rate is only as reliable as whoever promises it.