What are Decentralized Money Market Protocols?
Borrowing and lending money has always been a significant part of economic activity, and the economy itself. Lenders make funds available for either a fixed or variable interest rate, whereas borrowers use loans to achieve a wide variety of goals – from meeting basic consumption needs to making investments.
It is not just traditional money markets that make borrowing and lending of assets possible. The rise of DeFi (decentralized finance) has enabled users to borrow and lend their crypto assets in just a few clicks.
What are decentralized money market protocols, and what are their benefits?
Decentralized Money Market Protocols Explained
What is a decentralized money market? It is a market in which smart contracts enable investors to deal directly with each other – no middlemen involved.
A decentralized money market operates as a code on a highly decentralized network of nodes around the globe. The code is managed by a global community of stakeholders – unlike a traditional money market being operated by a centralized institution.
Let’s view an example of this.
Anchor is a decentralized lending and borrowing protocol that offers low volatility returns on Terra stablecoin deposits. Being open and permissionless, Anchor does not restrict access for third-party applications that can freely connect to the protocol and earn interest.
The Anchor rate is based on a diversified stream of participation rewards from the most notable Proof-of-Stake blockchains. As a result, Anchor ensures more stable savings than money market interest rates.
The Benefits of Decentralized Money Market Protocols
Decentralized money market protocols bring undeniable benefits to the consumer.
Firstly, decentralized money markets are grounded on smart contracts that follow predefined logic. These self-executing lines of code have the terms of an agreement between lender and borrower automatically verified and executed via a computer network This secures proper usage of funds.
In addition, there are no limitations as to who can be the user as compared to traditional money markets where, for instance, to get a loan, approval is needed from a central institution.
Furthermore, decentralized money markets function in an overcollateralized manner. This means that the value of an asset used as collateral on a loan exceeds the actual loan value.
Overcollateralization helps to effectively manage risk for the lender – borrowers who fail to pay back their debts will simply have their collateral liquidated.
Finally, decentralized money market protocols have a unique feature of asset tokenization. To explain in more detail, deposited funds become interest-bearing representations of the underlying assets that can be used in other dApps (decentralized applications). Why is it important? It drives the composability of DeFi (i.e., the interoperability of components within a system).
Considering all the advantages, decentralized money markets have added greatly to the use cases of smart contracts, becoming one of the most widely used applications in the DeFi industry.